Inconsistent Active Funds Bolsters the Case for Passive ETF

Active mutual fund managers that are able to deliver above-average returns one year are not guaranteed to deliver again. Consequently, investors who are less inclined to bet on an active strategy may look for more consistency with a passive, index-based exchange traded fund.

“When it comes to the active versus passive debate, one of the key measurements of successful active management lies in the ability of a manager or a strategy to deliver above-average returns consistently over multiple periods. Demonstrating the ability to outperform peers repeatedly can be one way to differentiate a manager’s luck from skill,” Aye M. Soe, Managing Director of Global Research & Design, and Ryan Poirier, Senior Analyst of Global Research & Design, wrote in a S&P Do Jones Indices research note.

According to the S&P Persistence Scorecard, only a few funds can consistently stay on top. Of the 568 domestic equity funds that placed in the top quartile at the end of March 2015, only 1.94% stayed there at the end of March 2017 – 0.92% of large-cap funds, 2.38% of mid-cap funds and 2.26% of small-cap funds remained in the top quartile.

Looking at a broader segment of performances, about 23.45% of large-cap funds, 11.38% of mid-caps funds and 22.1% of small-cap funds maintained a top-half ranking for the three years ended March 2017.

“An inverse relationship generally exists between the measurement time horizon and the ability of top-performing funds to maintain their status,” the analysts said. “It is worth noting that no large-cap, mid-cap, or small-cap funds managed to remain in the top quartile at the end of the five-year measurement period. This figure paints a negative picture regarding long-term persistence in mutual fund returns.”

The scorecard findings suggest that over short periods, the majority of active fund outperformances may have more to do with luck as active managers’ performances typically fall off over extended periods and even underperform given enough time.

Consequently, long-term investors who want a cheap and efficient way to gain exposure to broad markets should consider a passive, index-based ETF as a safe bet.

For more information on the fund industry, visit our mutual funds category.

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