SPIVA® Interpretation and Misinterpretation

I’ve been a long-time SPIVA® fan. The first report was published about 13 years ago and it quickly became my go-to active management scorecard. No firm was comparing active manager performance to index benchmarks regularly. Advisers had to crunch data themselves to see the trends. SPIVA came to the rescue by doing the heaving lifting, and now does it globally.

The S&P Dow Jones SPIVA® U.S. Scorecard is published semi-annually. It’s some twenty pages of hard-hitting data on active manager performance versus comparable market benchmarks. The report is parsed into multiple tables covering different time periods and different asset classes, and is provided in both equal-weight and asset-weighted returns. There’s also information on survivorship bias and style consistency.

The SPIVA® U.S. Year-End 2014 report compares data going back 10 years. Actively managed mutual funds routinely underperformed the indexes they were trying to beat in every asset class and almost every style. There were only two areas in the global market where the average active manager outperformed over the previous 10 years, and they didn’t do it by much.

One possible takeaway from SPIVA is that it might make sense to use index funds in categories where managers have done poorly and use active management where they have done well. You may have heard something like this before: “Index the efficient asset classes and use active management in inefficient asset classes.” That may sound reasonable, but it’s wrong.

There are no inefficient asset classes; there are only messy active managers. Index constituents in a style are a pure play while actively managed portfolios look like a shotgun blast across a broad section of the market with most constituents falling in the style. This messiness causes active funds to outperform a style index when the style performs poorly relative to adjacent styles. It also causes active funds to underperform when a style significantly outperforms adjacent styles.

Investors would be wrong to assume managers have an advantage in styles that are underperforming without considering the purity phenomena. What goes around comes around. Styles that underperformed in the past will reverse at some point and active managers will underperform. It could take one year or several years before a regression to the mean occurs, but it will happen.

Active managers have such a difficult time beating their benchmarks long-term in every style. The reason is simple math; it’s a zero-sum game. There’s only a finite amount of money that can be earned in the markets each year. When one active investor extracts more than his or her fair share, another one earns less – and this is before costs. Since no one invests for free, investment cost ultimately causes the average active fund in every category and style to underperform.

The lesson behind the SPIVA® U.S. Scorecard and its sister publication, SPIVA® Persistence Scorecard is that it’s darn hard to beat the markets – every market. This makes low-cost index funds and exchange-traded funds (ETFs) a wise choice.

For more information on this topic, I will be speaking at S&P DJI’s upcoming webinar, “Putting SPIVA to Practical Use in Portfolio Management” on May 12.

The posts on this blog are opinions, not advice. Please read our disclaimers.

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