By Ryan Gilmer, CFA – VP Investment Management – TOPS ETF Portfolios
Anyone who has ever entered a March Madness bracket pool for the NCAA tournament knows the feeling – it doesn’t take long before the teams you’ve picked to win start to lose – and your bracket fills up with red.
After the first weekend, most brackets have lots of mistakes. It’s easy to see why. The teams in the tournament are all pretty good, or else they wouldn’t qualify.
The difference between the teams isn’t that large, making it hard to predict with certainty who will win. Also, the first round alone has 32 games, so it’s going to be very difficult to make many correct predictions. Jeff Bergen, a professor at DePaul, estimates the chances of picking a perfect bracket at 1 in 128 billion. Many think the odds are worse than that.
My bracket strategy has changed over time. At first, it was fun to try and pick upsets. After all, upsets happen every year, so I knew a reasonable amount of the lower seeded teams would defeat higher seeds. Furthermore, picking an upset meant being contrarian. If anything, picking upsets gave me bragging rights with my friends.
The upset strategy had problems though. First, every upset that I picked was a low probability event, which meant that the favored team was likely to win, and I was likely to be wrong. Second, given the sheer number of games played in the tournament, it was likely that upsets I didn’t pick would occur, doing further destruction to my bracket. Most years, in the attempt to make my bracket better, I compounded my problems and made it worse. Needless to say, I didn’t end up feeling smarter than my friends.
Related: ETF Issuer March Madness
So now, I have a new bracket strategy. I only pick the favored teams to win. My motivation is no longer to pick the perfect bracket, a task which is highly unlikely, if not impossible. My new goal is to give myself the best possible chance of success. I know there will be upsets, but I also know that my chances of picking upsets regularly are not good. I am certainly not a college basketball expert, but even so-called experts have questionable ability to pick upsets consistently. Most of the time, the favored teams win, if they didn’t Vegas would be broke.
So, I’ve decided to align my bracket with the favorites. If you are trying to win your office pool, this strategy gives you the best statistical chance for success.
Every year, S&P Global updates the SPIVA US Scorecard. This report tracks the percentage of actively managed funds that outperform their index benchmark. It corrects for survivorship bias by adding back any funds that were liquidated or merged. It also assigns appropriate benchmarks and asset-weight returns, meaning the biggest funds have more impact than smaller funds. This methodology is used to accurately show what results most investors are getting.
Reports 1, 6, and 11 show the results of the study:
| Report 1: Percentage of US Equity Funds Outperformed by Benchmarks | ||||||
| Fund Category | Comparison Index | 1-Year % | 3-Year % | 5-Year % | 10-Year % | 15-Year % |
| All Domestic Funds | S&P Composite 1500 | 63.43% | 83.40% | 86.72% | 86.65% | 83.74% |
| All Large-Cap Funds | S&P 500 | 63.08% | 80.56% | 84.23% | 89.51% | 92.33% |
| All Mid-Cap Funds | S&P MidCap 400 | 44.41% | 86.34% | 85.06% | 96.48% | 94.81% |
| All Small-Cap Funds | S&P SmallCap 600 | 47.70% | 88.83% | 91.17% | 95.71% | 95.73% |
| All Multi-Cap Funds | S&P Composite 1500 | 56.46% | 83.64% | 84.91% | 90.70% | 87.67% |
| Large-Cap Growth Funds | S&P 500 Growth | 32.92% | 67.58% | 80.92% | 93.65% | 93.49% |
| Large-Cap Core Funds | S&P 500 | 68.98% | 88.45% | 90.99% | 94.95% | 94.67% |
| Large-Cap Value Funds | S&P 500 Value | 46.88% | 80.37% | 85.07% | 70.44% | 85.71% |
| Mid-Cap Growth Funds | S&P MidCap 400 Growth | 18.05% | 91.46% | 81.13% | 97.69% | 95.32% |
| Mid-Cap Core Funds | S&P MidCap 400 | 61.67% | 88.24% | 87.90% | 96.15% | 96.51% |
| Mid-Cap Value Funds | S&P MidCap 400 Value | 43.14% | 75.41% | 81.54% | 88.04% | 88.89% |
| Small-Cap Growth Funds | S&P SmallCap 600 Growth | 15.08% | 86.53% | 86.67% | 95.56% | 98.73% |
| Small-Cap Core Funds | S&P SmallCap 600 | 58.59% | 93.78% | 95.59% | 96.23% | 96.55% |
| Small-Cap Value Funds | S&P SmallCap 600 Value | 74.07% | 82.14% | 95.45% | 92.78% | 89.47% |
| Multi-Cap Growth Funds | S&P Composite 1500 Growth | 46.32% | 83.24% | 85.11% | 94.77% | 86.21% |
| Multi-Cap Core Funds | S&P Composite 1500 | 68.78% | 92.78% | 90.13% | 90.14% | 90.82% |
| Multi-Cap Value Funds | S&P Composite 1500 Value | 49.57% | 76.47% | 76.24% | 84.21% | 85.96% |
| Real Estate Funds | S&P United States REIT | 36.90% | 59.76% | 73.68% | 84.54% | 81.13% |
| Source: S&P Dow Jones Indices LLC. Data as of Dec. 29, 2017. Returns shown are annualized. Past performance is no guarantee of future results. | ||||||
| Table is provided for illustrative purposes. | ||||||
| Report 6: Percentage of International Equity Funds Outperformed by Benchmarks | ||||||
| Fund Category | Comparison Index | 1-Year % | 3-Year % | 5-Year % | 10-Year % | 15-Year % |
| Global Funds | S&P Global 1200 | 50.21% | 77.45% | 77.71% | 81.98% | 82.47% |
| International Funds | S&P International 700 | 53.95% | 69.40% | 70.93% | 81.68% | 91.63% |
| International Small-Cap Funds | S&P Developed Ex-US Small Cap | 44.05% | 65.75% | 65.52% | 72.55% | 78.13% |
| Emerging Markets Funds | S&P/IFCI Composite | 64.89% | 78.92% | 77.78% | 85.14% | 94.83% |
| Source: S&P Dow Jones Indices LLC. Data as of Dec. 29, 2017. Returns shown are annualized. Past performance is no guarantee of future results. | ||||||
| Table is provided for illustrative purposes. | ||||||
| Report 11: Percentage of Fixed Income Funds Outperformed by Benchmarks | ||||||
| Fund Category | Comparison Index | 1-Year % | 3-Year % | 5-Year % | 10-Year % | 15-Year % |
| Government Long Funds | Barclays US Government Long | 96.43% | 100.00% | 98.31% | 95.24% | 98.00% |
| Government Interm Funds | Barclays US Government Interm | 57.89% | 90.91% | 80.00% | 78.05% | 90.48% |
| Government Short Funds | Barclays US Government (1-3 Year) | 47.83% | 69.23% | 79.31% | 76.47% | 88.24% |
| Investment-Grade Long Funds | Barclays US Government/Credit Long | 96.74% | 94.68% | 95.45% | 95.40% | 97.73% |
| Investment-Grade Interm Funds | Barclays US Government/Credit Interm | 31.37% | 35.53% | 40.94% | 51.06% | 73.53% |
| Investment-Grade Short Funds | Barclays US Govt/Credit (1-3 Year) | 22.22% | 41.67% | 43.33% | 57.81% | 68.89% |
| High Yield Funds | Barclays US Corporate High Yield | 80.95% | 90.87% | 93.81% | 98.37% | 98.23% |
| Mortgage-Backed Securities Funds | Barclays US Aggregate Securitized MBS | 67.92% | 73.08% | 79.31% | 81.40% | 93.88% |
| Global Income Funds | Barclays Global Aggregate | 64.86% | 60.55% | 52.59% | 58.33% | 69.44% |
| Emerging Markets Debt Funds | Barclays Emerging Markets | 22.58% | 70.69% | 85.71% | 73.68% | 66.67% |
| General Municipal Debt Funds | S&P National AMT-Free Muni Bond | 42.86% | 58.75% | 47.50% | 63.29% | 82.88% |
| California Municipal Debt Funds | S&P California AMT-Free Muni Bond | 25.71% | 30.56% | 37.14% | 66.67% | 84.44% |
| New York Municipal Debt Funds | S&P New York AMT-Free Muni Bond | 33.33% | 57.14% | 73.33% | 85.29% | 89.47% |
| Loan Participation Funds | S&P/LSTA US Leveraged Loan 100 | 52.08% | 56.25% | 52.78% | 100.00% | – |
| Source: S&P Dow Jones Indices LLC. Data as of Dec. 29, 2017. Returns shown are annualized. Past performance is no guarantee of future results. | ||||||
| Table is provided for illustrative purposes. | ||||||
Each table shows the percentage of active funds that failed to beat the benchmark over the given time period. Just like the NCAA tournament, there can be upsets over shorter time periods. Even so, the results indicate just how difficult it is for most active funds to continue to outperform, especially over longer time periods and full market cycles. It also shows how this phenomenon persists over most asset classes, including diversifying holdings such as emerging market debt and international stocks, which have long been thought to benefit from active management.
In this case, over the long term, the index is usually heavily favored over an active manager. Choosing an index-based ETF portfolio, therefore, gives you the best chance of success. After all, we don’t want our investment portfolios to end up like our NCAA brackets.
Update, going into the Final Four, my bracket is currently winning in my league.
This article was written by Ryan Gilmer, CFA, who is Vice President – Investment Management at TOPS ETF Portfolios, a participant in the ETF Strategist Channel.
Disclosure
ValMark Advisers, Inc. (“ValMark”) is a federally registered investment adviser located in Akron, Ohio. ValMark and its representatives are in compliance with the current registration and notice filing requirements imposed upon federally covered investment advisers by those states in which ValMark maintains clients. For registration or additional information about ValMark, including its services and fees, a copy of our Form ADV is available upon request by contacting ValMark at 1-800-765-5201.
This article provides commentary on current economic and market conditions and is not directly relevant to any particular client account. The information contained herein should not be construed as personalized investment advice or recommendations to buy or sell any security. There can be no assurance that the views and opinions expressed in this article will come to pass. Investing involves the risk of loss, including the loss of principal.
Diversification cannot assure gains or protect against losses.
Past performance is no guarantee of future results. Information contained herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. Indexes are unmanaged and cannot be directly invested in.
Source: Bloomberg for historic price and return references.
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