During the last 15 years, 89% of all investment funds in the United States were not able to beat the S&P Composite 1500. In this article we will see how funds have evolved by category and explain, in a simple way, what is the interpretation of these numbers.
It would be a mistake to think that the objective of any investment fund, and of any investment vehicle in general, is to achieve the maximum possible profitability. Reality has many edges, it is multifactorial and hides different nuances.
However, given the scope and complexity of this debate, we will remain in the risk-return ratio. That is, as a general rule, for the same profitability, we will choose the option that has less volatility. A concept that investors try to use as a synonym for risk, although they are not the same, not even close.
Be that as it may, the industry, research papers, and investors generally assume that this is so. That is, volatility and risk are the same. So to simplify the explanation, we will adapt to that concept of risk supported by Nobel laureates such as Harry Markowitz or William Sharpe.
Having made the above clear, in this article we will see how many investment funds have achieved more profitability than the benchmarks they had set out to beat. If you do not know what a benchmark is, access here and to learn about the concept of an investment fund, here.
What information does the reference index or benchmark offer?
We assume that you cannot (or should not) compare the returns between two funds that invest in different assets. For example, we cannot (or should not) compare a fund that invests in fixed income with a fund that invests in equities. But what we can do is compare a fund that invests in bonds with a benchmark of the bond market or a mutual fund in stocks with a benchmark of the stock market.
Once we compare it, we will know if the fund is performing better or worse than the benchmark against which it is compared, that is, whether or not it meets its objective. In addition, all being said, funds usually indicate in their prospectus with which index they intend to compare.
The information provided by the brief discussion above is critical. Why? Because since we can invest directly in funds that replicate the index at a lower cost, what sense would it make to invest in an investment fund that is not capable of outperforming the index and also entails a much higher cost?
Again, there are nuances that could justify paying a higher cost for lower profitability. For example, an investment fund that achieves less profitability but is much more stable (less volatile). In other words, that its risk-return ratio is higher than that of the benchmark.
How many funds outperform the index?
The data as of December 31, 2019, reflects that during the previous 15 years, 89% of equity funds were not able to beat the benchmark S&P Composite 1500 index. Although this index is very general, the data reflect that this percentage can be even higher when comparing by category.
The following table shows the percentage of investment funds in the United States that did not beat their benchmark and therefore did not achieve their main objective.
As we can see in the table above, regardless of the fund category, in the best case (Large-Cap Value Funds), 81% of the funds failed to beat the benchmark over the last 15 years.
On the other hand, when it comes to fixed income funds, the reality is not much different in the long term.
After looking at the data above, two questions arise.
- Given that the data correspond to the United States, are the results similar in other continents?
- And, on the other hand, if we take into account the risk-return ratio, do the results change?
Answering the first question, according to the SPIVA results, many similarities are found in Europe.
And, regarding the second question, on the return-risk issue, the vast majority of equity funds have a worse return-to-risk ratio than their indices. In fact, when commissions are discounted (net of commissions), the results are even more bleak.
And, again, the return-to-risk performance of fixed income funds net of fees are very similar. Although it is true that the gross results of commissions are striking.
Finally, one might wonder if the risk-return ratio is so bleak in Europe. The answer, as this SPIVA document shows, is not very different from what was commented above.
In conclusion, 80-90% of funds are unable to outperform their benchmark. Not in the United States, not in Europe. And as if this were not enough, the data also shows that the higher management costs of active mutual funds are not justified by virtue of a better risk-return ratio. Therefore, it is not surprising that even Warren Buffett, one of the best investors of all time, recommends indexed passive management, which simply tries to replicate the index and not beat it, drastically reducing the costs of analysis of companies that have traditional investment funds.