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Ep 1: SPIVA Special
493 Plays2 years ago
The very first TEBI podcast, produced and sponsored by Regis Media. It’s 15 minutes long, and it features Craig Lazzara and Tim Edwards from S&P Dow Jones Indices on what the latest SPIVA data tells us about active fund performance.
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Transcript
Introduction to Evidence-Based Investing
00:00:05
Speaker
Hello and welcome to the first, yes, the very first of what I'm sure will be many podcasts from the evidence-based investor. I'm Robin Powell. This program is brought to you by Regis Media, connecting advisors with clients.
Understanding SPIVA
00:00:20
Speaker
Today, we're talking about SPIVA. Regular Tebbi followers will know straight away what I'm referring to. In case you're not one of them, SPIVA is a scorecard for fund managers compiled by S&P Dow Jones Indices.
00:00:35
Speaker
It stands for S&P Index vs Active and began in the US in 2002. It now covers fund performance all over the world. The latest figures for mid-year 2016 have been released over the last few weeks and they make pretty grim reading for actively managed funds and more importantly for investors who use them.
00:00:57
Speaker
Joining me on a phone line from New York City is Craig Lazara, S&P's global head of index investment strategy.
Performance of Active Managers
00:01:06
Speaker
Craig, what's the idea behind SPIVA? The point of the SPIVA exercise is to look at the actual returns of a large set of actively managed mutual funds. We do that in a particular way, which is adjusted for what we call survivorship bias, and by that I mean
00:01:27
Speaker
you want to make sure that all the funds that existed in two thousand ten actually report results for two thousand ten uh... you don't only want the funds that have survived to two thousand sixteen uh... because that obviously biases the sample uh... any event we take the the actual returns of actively managed mutual funds and then compare them to indices that are appropriate to that style of investment so for example
00:01:51
Speaker
In the U.S. we compare large cap mutual funds to the S&P 500, we compare small cap funds to the S&P small cap 600, mid cap to the mid cap 400, Canada to the CSX composite, Australia, Europe and so forth, all things set against appropriate local benchmarks. Broadly speaking then Craig, what do you tend to find? Most of the time the majority and in some cases the vast majority
00:02:17
Speaker
of active managers underperform the benchmark that's appropriate to their investment style. And that has continued to be true when we updated for mid-year 2016. For example, 85% of all U.S. large-cap managers underperformed for the 12 months ended June 30, 2016.
00:02:40
Speaker
Similar percentages for mid cap and small cap, similar percentages for Europe and the UK specifically. If you go back longer periods of time, say instead of looking at just the last 12 months, we look at the last five years, or even what we can with the data permitted, the last 10 years,
00:02:59
Speaker
The result doesn't
Challenges in Active Management
00:03:00
Speaker
change. In fact, it typically gets worse. Of course, all this begs the question, why do actively managed funds perform quite so poorly? Craig, what do you make of that? The overall reason is that active management is particularly difficult and it's difficult for a particular reason.
00:03:17
Speaker
the reason is that if there's no natural source of alpha alpha in the business and think of it as excess return the amount by which an active manager outperforms a passive benchmark there's no natural source of alpha another way to say that is that if i'm going to be able to say by managing actively at the u.s. market if i'm going to be above average somebody else has to be below average there's no there's no source of winnings for the winners
00:03:47
Speaker
other than the losses of the losers well that means that active investing generally speaking is what you might call a zero-sum game but it's a zero-sum game that you have to pay to get into because obviously you have to pay research cost trading cost management fees and so forth in order to be an active manager and that biases the results downward so you might expect over time eighty fifty five or so percent of active managers to underperform
00:04:14
Speaker
what we see in the u.s. of the last several years and certainly as you say continues into the most recent report is that the percentage of underperformance is much higher that somewhere in the neighborhood of eighty uh... or more than eighty percent which is really quite high by historical standards now the particular reason for that uh... i i think uh... relates to a concept that we call dispersion think of dispersion as uh...
00:04:40
Speaker
Well, formally, it's the standard deviation of returns of stocks in the S&P 500 on a monthly basis. That's the technical definition. The intuitive definition is that you think of dispersion as the gap between the best performing stocks and the worst performing stocks. So in a period of high dispersion, the winners, at a stock level, the winners are doing a lot better than the losers.
00:05:07
Speaker
in a period of low dispersion the winners are doing the obviously better than the losers but by a much more but much more contained and muted march in the u.s. uh... since roughly two thousand eleven two thousand twelve dispersion has been extremely low uh... two thousand fourteen was actually the lowest year for which we have records last twenty five years and it hasn't gotten any better or not certainly not much better in two thousand sixteen was quite low over the summer
00:05:37
Speaker
Now, what low dispersion means is that even for an active manager, let's say we acknowledge that we've identified an active manager with genuine stock selection skill, what dispersion helps measure is the value of his skill. Because even if I could always pick the top quartile of stocks in the S&P 500, for example,
00:06:02
Speaker
If the difference in performance between the top quartile and the average is very small, the value of my skill is much less.
The Role of Skill and Luck in Performance
00:06:11
Speaker
Now, as you'd expect, there are some funds that do manage to outperform. But Craig, you've also done some interesting research into the persistence of outperformance, haven't you? What does that data tell us? We've only done this in the US so far, but the depth of the data here is really quite good. But what we'll do is go back five years,
00:06:31
Speaker
identify all the funds in a category that were above average. And I say above average means above average relative to the other active managers. That makes no reference to whether those funds outperform or underperform the S&P 500, for example. So take all the funds, say all the large cap funds that were above average five years ago, and then say, okay, above average funds five years ago, how many were also above average four years ago, three years, two years, one year? And so you're just measuring through time
00:06:59
Speaker
Starting with a group that we know five years ago was the set of best performers, and then say how well did they do over time. Obviously, if all of the guys who outperformed or were above average five years ago or above average in each of the years since then, that's pretty strong evidence that there's a group of skillful managers, and here's who they are.
00:07:22
Speaker
uh... what we find however is if you do that exercises task how many years of the last four of the above average set from five years ago as above average the answer typically is of the range and we did this exercise uh... bill several months ago for the u.s. the answer typically ranges between though let's say you know three-and-a-half that six-and-a-half percent that's uh...
00:07:49
Speaker
That's kind of where it typically ends up. There's some deviations from that. And if you look at these specific fund categories, large cap, mid cap, small cap, it's all kind of in the same range. Now, the significance of that number is if I try to flip a coin four times in a row, the chance of four heads in a row is about exactly, in fact, it's a fair coin, 6.25%. And the last time we did the exercise,
00:08:16
Speaker
uh... the percentage of large cap managers who uh... who were above average five years who did uh... or above average if the subsequent four years was three point seven percent uh... for big cap on this five point eight the small cap a little better seven point seven point eight so i always tell people we discuss uh... persistence you have statistically speaking you have a better chance of flipping four heads in a row that you do have identified a manager who's going to be above average four years
00:08:45
Speaker
Craig Lazarra, thank you very much. In a moment, we'll be looking specifically at the latest Spiva data for the UK and Europe. But first, here's a message from our sponsor.
Marketing Support and Regional Performance
00:08:56
Speaker
Hi it's Will, I'm a producer from Regis Media. We know running a financial advisory firm is hard work, but we also know the value of high quality regular content and marketing. And that's where we come in. We support firms by helping them attract and retain clients through a mixture of video content, social marketing and written articles. To find out more visit our website RegisMedia.com
00:09:20
Speaker
So we've heard from Craig Lazara on the global picture for ActiveFun Performance. Let's take a closer look now at what's happening in Europe. Joining me is Tim Edwards, Senior Director of Index Strategy at S&P Dow Jones in London. Tim, what struck you most about the mid-year SPIVA data for Europe?
00:09:39
Speaker
Hi Robin, I think the first thing was how striking the data really is at this particular point in time. Normally, if you didn't know and you were going to guess, you'd sort of assume that maybe you'd see 40% of managers outperforming, 60% underperforming.
00:09:56
Speaker
What we've seen over the last year and over the past couple of years, this is a strengthening trend, is those numbers getting higher and higher. And at the last report, we're seeing sort of fund underperformance numbers in the high 80s and some really striking figures when you look at European buttons invested in US equities and 99% underperformance. So that was the first surprise.
00:10:19
Speaker
And Tim, what about UK fund managers? To be fair to them, they've not done badly in recent years, but they've had a pretty disastrous 12 months. Yes, that was the other interesting little snippet, which is that in previous, and we've been running this report in Europe for about three years now, and in previous years, what we saw was consistent outperformance from UK managers invested in UK stocks. Two theories for this, one that British fund managers are particularly talented and uniquely qualified to make more money than anyone else. It's a theory I like.
00:10:49
Speaker
And the other one was it might be because of a bias away from the titans of the London Stock Exchange and into smaller companies, which had been performing very well. That made this particular report really interesting and an acid test, if you like, because what happened just as we were compiling the data for this was, of course, the UK vote for Brexit.
00:11:09
Speaker
And that had a very distinguished effect where large multinationals, Unilever, BP and so on traded in London, very international revenue sources weren't affected by the falling pound. And in fact, actually, the pound price of their stocks rose as the pound fell. And more domestic, smaller, medium companies in the UK doing very badly.
00:11:31
Speaker
Now, the reason that's absolutely fundamentally interesting for this kind of data is that if it's true that UK managers had been doing so well simply because of a bias towards mid-cap stocks, then Brexit was a real asset test. Did they manage to rotate into large caps and go into the safety of globally diversified revenue sources in advance of that sort of risky vote?
00:11:54
Speaker
And what we see in the data is this is actually the first time that we've seen UK large cap equity managers trailing the benchmark and again in the order of 91% over the last year.
00:12:07
Speaker
It's a difficult one, Tim, isn't it? Because of course you'd very much like to think that your fund manager could get out of a particular asset class just before it falls and into another as it starts to rise. But as we all know, that's extremely difficult to do. And perhaps more worrying for investors in active funds is that the manager might be straying into riskier assets than they feel comfortable with. Their overall portfolio might in fact be rather riskier than they thought.
Risks in Active Fund Management
00:12:34
Speaker
Funds are not sold in isolation and you might have a situation where an investor has a mid-cap fund and a large-cap fund and they like mid-caps and they want mid-caps and they bought a mid-cap fund and then they got a large-cap fund. It's not very useful to that end investor if that large-cap fund is then deciding to go into mid-caps. That's really a question of the individual funds, how are they sold, how are they branded and there is a wider question here around
00:13:00
Speaker
moving away from just the UK if you've got a US based equity fund that's taking exposures to emerging market equities and beyond that in the bond markets it's been a very very well established way to boost the returns by just taking on a little bit more credit risk. The critical point here is while that may be occasionally wise and may make more money it's not always helpful to the investor because maybe they had a particular risk budget
00:13:26
Speaker
and they've used or particularly wish to be in mid cap stocks and they're already using it elsewhere. Briefly Tim because we're running out of time you did in fact carry out some separate research into risk earlier in the year. Tell me about that.
00:13:38
Speaker
The concept was people don't necessarily just use active managers to deliver returns. Sometimes it's to manage risk. And so we thought we'd have a look. And just as we do in SPIVA, as we look at returns and how many funds offer better returns than a benchmark, we did quite an in-depth report on how many funds offer more or less risk than their benchmark.
00:13:58
Speaker
The conclusion was that actually, most of the time, most funds have actually a greater or higher risk profile than their respective benchmarks. So they're kind of losing on one and losing on the other. No real evidence about performance and a bias towards a little bit more risk as well. I think the conclusion is that while there are good funds out there, good active funds out there, they can be extremely hard to find.
00:14:25
Speaker
Indeed so. Thank you to Tim Edwards and to Craig Lazara from S&P Dow Jones Indices.
Conclusion and Acknowledgments
00:14:31
Speaker
You've been listening to the very first podcast from the evidence-based investor with me, Robin Powell. It's been brought to you by Regis Media, connecting advisors with clients. Find out more at RegisMedia.com. That's RegisMedia.com. Until next time, goodbye.