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- Index funds outperformed actively managed funds during the first quarter 2020 bear market.
- Index funds have outperformed actively managed funds during the April month-to-date rally.
- Patton Funds utilizes only index funds in client portfolios.
Actively managed funds, those that try to buy the right things at the right time in an effort to beat an index, fail once again. This has been a persistent story for many years but still is debated in the industry because of the vast amount of revenue, or fees from investors, that is at stake.
Multiple sources document the fact that index funds consistently outperform the average actively managed fund. According to Standard & Poor’s, during the 10 years ending June 2019, 87.88% of U.S. funds have underperformed their respective index! If you’ve wondered whether or not this reality continues, wonder no longer. It does!
Understanding Types of Funds and Indexes
Remember that every asset class, or category of investment, has a different index representing its performance. For example, the S&P 500 is the index representing the performance of LARGE U.S. stocks. The performance of small U.S. stocks though is represented by the Russell 2000 Index. International stocks have different indexes as do various types of bonds and more.
Within each investment category, there are both active funds and index funds. An index fund will simply own all of the securities in an index, such as all 500 stocks in the S&P 500 or all 2000 stocks in the Russell 2000. An actively managed fund will instead purchase a select group of securities in an attempt to perform better than their respective index. Actively managed funds have proven to be a failure for investors delivering returns consistently below the respective indexes.
One argument for the failure of actively managed funds is that the last 10 years has been almost exclusively a roaring bull market. During strong bull markets when nearly all stocks are going higher and investors possibly pay less attention to the quality of a company, active managers argue it is harder to select some stocks that will do better than others. They suggest they will shine in a bear market but here we are and it hasn’t happened!
First Quarter 2020 Performance
The accompanying table shows the performance of 10 different investment categories during the first quarter of the year. Included is both the performance of the average actively managed fund in each category as well as the performance of an index fund. For example, the average actively managed fund in the “Large Blend” category, the category for large U.S. stocks, fell -20.9% while an S&P 500 index fund was off just -19.4%. In other words, the index fund beat the average actively managed fund by +1.5%.
Source: www.MutualFundExpert.com data, Patton analysis. See below for more details.
As you can see in the “Difference” column in the above table, the index fund did better than the average actively managed fund in every category except one during the first quarter. This certainly refutes any argument that actively managed funds will shine in a bear market. They did not do so this time and did not do so in past bear markets as well.
April Month-to-Date Performance
Since the end of the quarter, markets have turned around and moved sharply higher raising the question as to whether actively managed funds bounced back faster. They did not! See the following table.
Source: www.YCharts.com data, Patton analysis. See below for more details.
Again, as you can see in the “Difference” column in the table above, the index fund beat the average actively managed fund in 7 of the 10 categories April month-to-date. So not only did these funds generally perform worse during the falling market, they also tended to lag behind during this short and sharp recovery.
Some Actively Managed Funds DO Outperform
There are some funds that do better than the index during various periods of time. As noted above, 87.88% of U.S. funds failed to beat their index for a recent 10-year period but that does mean 12.12% did do better. That’s a small margin. There have also, of course, been funds that did better than the indexes both during the first quarter of this year as well as during the April rally.
The challenge is predicting beforehand which funds will do better. This has proven nearly impossible. You would simply need good luck on your side to select the better performers. You would actually need a tremendous amount of good luck because, if you have a diversified portfolio, you would need to select such a fund in each category of your portfolio.
Implication for Investors
Investors in a diversified portfolio of index funds simply get better returns than investors in a diversified portfolio of actively managed funds. Depending on the investment category and the time period, the improved performance can be 1% - 2% annually. This adds up to a huge amount of money over time.
At Patton Funds, we only utilize index funds in our clients’ portfolios.
Disclosure and Sources
First quarter 2020 data came from www.MutualFundExpert.com. April month-to-date data came from www.YCharts.com. Index funds, enhanced index funds, those with no symbol, those with no return for the period, and those reporting no assets were excluded.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. Any specific securities or investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own situation before making any investment decision including whether to retain an investment adviser.
All expressions of opinion are subject to change without notice in reaction to shifting market, economic or political conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. This content was created as of the specific date indicated and reflects the author’s views as of that date. Supporting documentation for any claims or statistical information is available upon request.
Past performance is no guarantee of future results. Any comments about the performance of securities, markets, or indexes and any opinions presented are not to be viewed as indicators of future performance.
Investing involves risk including loss of principal.
Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly. For more information on specific indexes please see full disclosure here.
Any charts, tables, forecasts, etc. contained herein are for illustrative purposes only, may be based upon proprietary research, and are developed through analysis of historical public data.
All corporate names shown above are for illustrative purposes only and are NOT recommendations.
International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.
Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Lower-rated securities are subject to greater credit risk, default risk, and liquidity risk.