Passive Investing 101

SPIVA: Doomsday for active fund managers?

If there is ever a financial research piece that active managers would love to banish to the deep depths of hell, it would be the SPIVA Scorecard.

SPIVA stands for S&P Indices Versus Active and the SPIVA Scorecard is a research paper published by S&P DJI that compares the performance of actively managed funds against their appropriate benchmarks. The results are not exactly rainbows and sunshine for the active fund houses. Pretty much a train wreck.

The ultimate objective of an active fund is to outperform its benchmark aka generating alpha.

Key takeaways from end-2018 SPIVA report 

For the uninitiated, note that lagged means underperformed. 

United States

  • Equity
    • Over a 15-year horizon,
      • 88.97% of domestic funds lagged the associated benchmark
      • 91.62% of large-cap funds lagged the associated benchmark
      • 92.71% of mid-cap funds lagged the associated benchmark
      • 96.73% of small-cap funds lagged the associated benchmark
    • One shining spot
      • Over one year ending 2018, approx. 85% of mid-cap growth funds outperformed the associated benchmark
        • However, over a 15-year horizon, 91.45% of the funds lagged the same benchmark
  • Fixed Income / Bonds
    • Over a 15-year horizon,
      • 98.04% of government long funds lagged the associated benchmark
      • 98.41% of investment-grade long funds lagged the associated benchmark
        • However, for the same benchmark, over one year ending 2018, approx. 91% of the funds outperformed
      • 99.15% of high yield funds lagged the associated benchmarks


Some argued that superior returns could be found in less developed markets which may be true from a theoretical perspective. A less developed capital market may suggest a higher probability that the securities may not be efficiently priced and therefore may present more opportunities for price/value discovery.

I have selected India as a representative country for the less developed markets. SPIVA does not conduct the research and/or publish results on the emerging markets as a whole but instead as individual countries. Note that China (for whatever reasons unknown to me) is not part of the list of countries that SPIVA conduct their research on. Else, I would have used China for this comparison. It would be very interesting to see how active funds in China had fared in the market.

  • Equity
    • Over a 10-year horizon,
      • 64.23% of domestic large-cap funds lagged the associated benchmark
      • 55.26% of mid-/small-cap funds lagged the associated benchmark
        • However, for the same benchmark, over one year ending 2018, approx. 75% of the funds outperformed
  • Fixed Income / Bonds 
    • Over a 10-year horizon,
      • 96.43% of government bond funds lagged the associated benchmark

From the SPIVA report, it seems to suggest that from a practical perspective, generating alpha in the less developed capital markets proved to be difficult as well. Note that this observation may not be conclusive for all countries in the emerging markets.

For more information on the results, see:

What to decipher from the SPIVA report?

Well, I believe the results are pretty damming with regards to the effectiveness of active management as a whole over a long period. I am not stating that active management cannot produce superior return or alpha. In fact, active management can and should produce superior return considering the nature and cost associated with active management.

However, the probability of managers picking winning stocks consistently over a long period is slim which is just as good as the probability of you as a retail investor picking winning funds over a long period.

Keyword being probability and consistently.

Efficient Market Hypothesis (EMH)

EMH is an investment theory that posits that securities prices reflect all the available information. Therefore, it is not possible to produce consistent alpha over the long run, through the use of fundamental and/or technical analysis. Only insider information can produce alpha. This theory was developed by Eugene Farma in the 1960s.

For obvious reasons, active managers typically reject EMH.

Active managers are not exactly advocates of the efficient market hypothesis. Active managers rely on the inefficiency in the capital markets to find mispriced securities to achieve alpha in the long run.

There are 3 different forms of EMH: 1) weak-form efficiency 2) semi-strong-form efficiency 3) strong-form efficiency.

Weak-form efficiency 

Posits that future securities prices cannot be predicted by analysing historical prices. Technical analysis will not be able to produce alpha however some form of fundamental analysis may still be able to produce alpha under the weak-form efficiency.

Semi-strong-form efficiency 

Posits that securities prices react to publicly available information very rapidly, such that no alpha can be achieved by trading on that information. This form of efficiency also states that both fundamental and technical analysis would not be able to produce consistent alpha.

Strong-form efficiency 

Posits that securities prices reflect all public and private information and that no one can achieve alpha.

My take is that a more realistic and practical form of EMH probably lies between the semi-strong-form and the strong-form efficiency.

EMH’s criticism 

Warren Buffett. End of story. Just joking.

Some critics often named Warren Buffet as a counterpoint against EMH. But sadly, most active fund managers are no Warren Buffett. Finding individuals with phenomenal stock picking abilities that can generate consistent alpha across the decades are extremely rare. Mr Warren Buffett is one such genius. Charlie Munger as well.

One prominent school of thought that challenge the EMH is the fundamentalists.


Fundamental analysis seeks to determine the firm’s intrinsic value. If the current price of the firm’s stock price is above/under the firm’s intrinsic value, the firm is said to be overvalued/undervalued respectively, which in turn, may justify a sell/buy rating of the firm’s stock.

Does fundamental analysis really produce superior returns over the long run?

Well, I believe my summary of the key takeaways from the 2018 SPIVA report pretty much sums up the effectiveness of fundamental analysis over the long run.

Total Expense Ratio & Performance

Fees play a major role as to why most active managers underperform. High fees put the active managers behind the starting line as compared to a cheap index fund.

Always find out what is the total expense ratio (TER) of a fund rather than just the management fee. TER is a more comprehensive fee structure that encompasses management fee, administrative fees, custodian charges and etc.

It is the total operating cost of managing a fund.

Suppose a manager manages an active US-equity large-cap fund that has a TER of 1%, is benchmarked against the S&P 500 Index. An ETF that tracks the S&P 500 Index is the Vanguard S&P 500 ETF (VOO), which has a TER of 0.03%.

The active fund would need to perform an additional 97 bps above the benchmark just to be on par with VOO. For example, assuming that the S&P 500 Index performed 15% in 2018,

  • VOO
    • Similar to other S&P 500 ETFs (SPY and IVV), VOO is extremely efficient, therefore VOO’s gross return would be equal to the gross return of the S&P 500 Index
    • VOO’s gross return = 15%
    • VOO’s net return = 15% – 0.03% (TER) = 14.97%
  • To be on par with VOO on a net basis
    • On a gross basis, the active fund would need to perform 15.97%
      • On a gross basis, you might notice that the active fund has outperformed the S&P 500 Index by 0.97% 
    • On a net basis,
      • Active fund’s net return = 15.97% – 1% (TER) = 14.97%
      • Active fund’s alpha = 0%

Note that the net return does not include the trading cost of entering/liquidating a position, and taxes.

For the active fund to be just on par with VOO on a net basis, the fund would need to outperform the benchmark on a gross basis by a whopping 0.97%. No small feat in a developed capital market. Furthermore, the active fund would need to outperform the market on a net basis to justify its 1% price tag to the investor. Therefore, on a gross basis, the fund would need to outperform by more than 0.97%, to deliver positive alpha on a net basis to the investor.

For more information on VOO, see:

1% = 100 basis points (bps)

To active managers’ credit

Active fund houses are not going to just sit there and let the passive funds eat their lunch. For the past couple of years, active managers are either fighting back in the form of lower fees or offering passive funds in their product lineup. In addition, active fund houses are increasingly packaging their active strategies into an ETF wrapper rather than the mutual fund structure which allows them to lower their active funds’ TER due to the more optimal operational efficiency of running an ETF.

Even though active funds’ TERs are not anywhere near what passive funds are charging, it is still a commendable effort on their part.

Do active funds have a role in your portfolio?

For the enterprising investors with time to spare for research, allocating 5% to 10% of your portfolio to active funds may do no ‘significant’ harm and may even potentially provide a better risk-adjusted return for your investment portfolio.

For the ‘laid-back’ investors, you probably better off with broadly diversified index funds over the long run. And there is a good chance that your investment portfolio will perform better than that of an enterprising investor.

At the end of the day…..

If active funds are your thing, then open your eyes wide and question your advisor on what you are really paying for. Are you paying for the research behind it or the technological advantage that the manager may have?

While past lacklustre performance may not be indicative of future lacklustre performance, the probability of active managers producing awe-inspiring returns consistently across the future decades is very slim.

As always, take personal responsibility of your financial well-being and do your own due diligence.



Disclaimer: This article does not constitute a solicitation to buy/sell any securities that may be mentioned in this article. At the time of writing and publication, the author does not hold any position in any of the securities mentioned in this article. I am writing in my personal capacity and my views do not represent that of any organisations.  

11 replies »

  1. Yeah, more & more active mutual funds/unit trusts are going to convert into active ETFs, especially in the US where taxes are such a big deal. And the recent ETF tax rule basically leveled the playing field for tax treatment of short-term trading versus long-term trading within ETFs (but not mutual funds, go figure). Basically short-term buy/sell within US ETFs are now treated the same as long-term buy/sell & will be subjected to lower taxes.

    Cost to launch a new ETF in the US has also come down a lot, low 5-figures or even 4-figures today, compared to mid-6 figures or 7-figures over a decade ago.

    Currently in the US, there are already a ton of active ETFs, but mostly “rules-based active” e.g. smart beta, quantitative strategies, rather than “discretionary active” by portfolio managers or investment teams.

    Need to be careful when investing in ETFs as to their makeup i.e. physical versus derivatives, as well as process e.g. using boring long established market cap weighted mainstream indexes, or new-fangled quantitative indexes where constituent stocks are included/excluded based on various metrics and rules. Some are even updated daily or weekly which results in massive trading or turnover.

    Liked by 1 person

    • In general, I believe it is a good thing for active management to take the form of an ETF structure since it will lower their operational cost and in turn, lower their TER. Hopefully, it may present a turnaround for them and outperform consistently (finger cross but I doubt it will happen)


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