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Majority of actively managed funds underperform: Benedek Voros, Director, S&P Dow Jones Indices

Rather than anecdotes and subjective opinions, the debate between active-passive debate is informed by dispassionate, objective analysis.

Active, passive funds, comparison, returns, mutual funds,
The rise of passive management is the consequence of active performance shortfalls.

The debate over passive versus active fund management is an unending one. To an investor, what matters is the performance leading up to the financial goal that one wants to achieve. In an actively managed fund, the role of a fund manager is crucial. However, the fund manager has no say in the selection and allocation of stocks and sectors in passive fund management – as in index mutual funds.

In an exclusive email interview with Sunil Dhawan of Financial Express Online, Benedek Voros, Director, Index Investment Strategy at S&P Dow Jones Indices (S&P DJI), shares his views on the passive funds, their advantage over active funds and why it has been difficult for fund managers to consistently beat the index over the short -medium and long term. Excerpts:

The debate between passive and active funds has been there for many years now. How challenging is this debate for Index Providers?

Rather than anecdotes and subjective opinions, the debate between active-passive debate is informed by dispassionate, objective analysis. The methodology that S&P DJI employs in its SPIVA Scorecards is rooted in fundamental principles that ensure an objective, fair comparison of active funds to an appropriate benchmark.

How has been the performance of actively managed funds as against the passive funds over different time frames?

The conclusions of our research across regions are remarkably consistent: over longer, 5-year and 10-year time horizons, the majority of actively managed funds underperform in most categories, be it an emerging or a developed market. Our findings in India are no different, with 64% – 98% of active funds underperforming their benchmarks over a 10-year horizon in four of the five categories we analyze. The sole exception to this trend is Indian Equity Mid-/Small-Cap Funds, exactly 50% of which managed to outperform their benchmark.

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How difficult has it been for fund managers to consistently beat the index over the short -medium and long term?

We observed across geographies, including India, that over shorter-term time horizons, underperformance rates are more volatile, while over the longer term, they are more stable and on average higher than over the shorter term, that is, it has proven more difficult for fund managers to beat their benchmark over longer time horizons.

This effect is analogous to the roulette wheel in a casino, where a lucky player may win on a small number of spins, but over many spins, the house’s advantage is insurmountable. The data suggest that an active manager is like a roulette player—(s)he has a small probability of winning in the short run, but an overwhelming probability of losing in the long run.

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What could be the reasons for the underperformance of active funds?

When thinking about the growth of indexing, it is useful to keep in mind that the rise of passive management is the consequence of active performance shortfalls, which in turn can be attributed to three key factors: the professionalization of investment management; the higher costs of active funds; and the skewness of stock returns. Since each of these factors is likely to persist, the advantage of indexing over active management is likely to persist as well.

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First published on: 09-05-2023 at 14:59 IST