Many active strategies have fallen short of their benchmarks and passive exchange traded funds over the years as simple and concise indexing rules help keep index-based strategies on track.
Over the past five years, only 21% of active mutual funds have outperformed their benchmarks, reports Julie Verhage for Bloomberg.
Consequently, investors have funneled billions into low-cost, index-based funds that try to passively reflect the performance of the benchmark indices.
For instance, the S&P 500 index now has $7.8 trillion following it with $2.16 trillion of that coming by way of exchange traded funds, mutual funds and other investment products. The largest S&P 500 ETFs include the $178 billion SPDR S&P 500 ETF (NYSEArca: SPY), the $69.2 billion iShares Core S&P 500 ETF (NYSEArca: IVV) and the $32.6 billion Vanguard 500 Index (NYSEArca: VOO). [There’s $7.8 Trillion Benchmarked to the S&P 500]
According to Morgan Stanley, one of the main reasons why the S&P 500 benchmark is outperforming active strategies is because of the S&P 500’s indexing methodology. Specifically, the S&P tends to remove companies and add others that typically outperform.
“The median stock removed from the S&P 500 has negative earnings growth in the preceding three and five year periods,” Morgan Stanley analysts said in a note. “The earnings growth of the companies added to the index was not only much superior to the companies removed but also much higher than those companies already in the index.”