How active beat passive in 2017

Despite relatively large equity returns last year, passive management didn’t emerge as the management winner in 2017.

About 63% of U.S. funds underperformed the index last year, finds the SPIVA U.S. scorecard.

However, on an asset-weighted basis, which better reveals active management, all U.S. large-cap funds returned about 22.8%, compared to about 21.8% for the S&P 500, notes a market report from Richardson GMP.

“Asset-weighted is a fairer representation of what an investor experienced with their money,” says Richardson GMP.

The outperformance on an asset-weighted basis was even greater among mid- and small-cap funds, says Richardson GMP. Its report provides a chart showing asset-weighted returns for these funds relative to their indexes.

For example, asset-weighted returns for mid-cap funds were about 20% compared to about 16% for the S&P MidCap 400.

“These results are actually surprising,” says Richardson GMP, since market returns were relatively large in the past year. Further, the biggest large-cap funds were major contributors to returns, with the top 10 companies in the S&P 500 representing 6% of the index’s return.

“Usually when the mega caps lead or contribute so much of the gains, it is simply harder for an active manager to outperform a market capitalization-based index, as they tend to be more broadly diversified,” says the report.

One reason for active’s decent showing last year is stock disparity. In fact, last year saw the highest disparity since 2010, says Richardson GMP, and, so far in 2018, the trend of rising disparity has continued.

“The index had been moving more homogenously for many of the past years, with all stocks moving more closely together,” says the firm. “And now that appears to be loosening up, giving an advantage to active managers.”

However, despite these results, investors shouldn’t bail on passive.

“We remain fans of both active and passive management styles, for different reasons,” says Richardson GMP.

On the plus side for passive management, it can provide broad market exposure at an attractive price. Says the firm: “Asset-weighted relative returns over the past three, five and 10 years certainly still point to an historical period that passive dominated.”

The firm’s report also notes that active fees have been coming down, and active approaches are changing.

“Acknowledging any strategy that is similar to a broad index will be readily replaced with a lower cost index solution, many managers have now deployed strategies that are very different than the index,” says the report. That means designing strategies to better complement an index ETF within the portfolio or determining the best strategy to beat the index based on its composition.

Referring to the increase in ETF and high-frequency trading, which are transforming the market, Richardson GMP concludes that “when the investment landscape changes, successful investment strategies must adapt as well. This isn’t your grandpa’s market.”

For more market details, read the full GMP Richardson report and the Spiva U.S. scorecard.

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