Did active managers outperform in the crash?

One of the biggest advantages active managers have is their ability to manage risk. Unlike passive funds, which must buy and hold an index, active managers can shift their portfolios as market conditions change.

This is what supports the argument that active managers will outperform when markets fall. While index funds must decline in line with the market, active managers are able to get some protection in cash, and by picking stocks that will be less affected.

There is also some evidence that they do this. Style Analytics, a factor and ESG (environmental, social and governance) analysis firm, published research just last month showing that when markets fall the top-performing managers outperform the market more often than when markets go up. This was based on 25 years of data from 1995 to 2020.

Style Analytics found that the top 25% of active large cap US fund managers outperformed the Russell 1000 Index in only 51.3% of the months the index was up. In the months it was down, however, the top 25% of active managers outperformed 59.8% of the time.

Among the top 5% of active managers, the difference is even greater. They outperformed the Russell 1000 60% of the time when markets go up, but 76.4% of the time when markets go down.

Source: Style Analytics

Times of crisis

The analysis also found that in the four most severe down markets over this period, the top-performing active managers were even more likely to outperform. This is evidenced by analysing fund returns during the tech bubble in the early 2000s, the global financial crisis from 2007 to 2009, the debt downgrade in 2011, and the taper tantrum in 2018.

During these four periods, active managers outperformed at an even higher ratio than during more benign negative markets.

Source: Style Analytics

Research published by Morningstar two years ago made similar findings. Analysing a 20-year period – February 1, 1998 to January 31, 2018 – Morningstar noted that, on average, more than half of US equity funds underperformed a relevant index over rolling 36-month periods. This is illustrated in the graph below.

Source: Morningstar

However, Morningstar identified that there was a distinct difference in how active managers performed in those 36-month periods when the benchmark index was up, and those when it was down.

“We found that active US equity funds were indeed likelier to succeed in down periods than up periods during the 20-year span we examined,” noted the author of the research, Jeffrey Ptak. “All told, nearly 60% of active US equity funds outperformed their bogy in down periods, on average. By contrast, only about 32% of active US stock funds beat their indexes in up periods, on average, meaning the odds of succeeding were almost twice as good when the market was down than when it was up.”

Good enough?

However, as Ptak noted, these findings come with two significant caveats. The first, and most obvious, is that markets go up a lot more than they go down.

Even though active managers were more likely to outperform in falling markets, they were still more likely to underperform when considering the full 20-year period.

“Moreover, when active funds succeeded, they tended not to sustain their outperformance,” Ptak pointed out.

“Only about a third of successful funds went on to outperform in the next, non-overlapping 36-month period.”

In other words, investors still have to identify in advance which funds are going to outperform. And that is notoriously difficult, particularly because past performance is no guarantee of future success.

The recent experience

This is an important consideration to bear in mind when looking at how local equity funds performed during the recent crash. According to analysis from CoreShares, 31% of South African general equity funds outperformed the CoreShares Top 50 ETF from the market open on February 24 to the close on April 6.

This is significantly higher than the 6.1% of active funds that beat the S&P South Africa Top 50 Index for the three years to the end of December 2019. Quite clearly, then, active managers were better able to add value over this period.

However, it was still far from a majority that outperformed. Most active funds did not.

And, significantly, investors hardly demonstrated an ability to identify these outperformers beforehand. As CoreShares found, eight of the 10 largest local equity funds underperformed the CoreShares Top 50 ETF over this period.

As these 10 funds have a market share of 49%, one can safely say that investors did not show any great prescience in their fund selection.

In fact, the funds most likely to outperform were smaller, more nimble portfolios that could shift their portfolios more aggressively and more easily. These are funds with relatively small market shares.

This is highlighted by the fact that the average return of the 10 largest equity funds over this period was 1.5% lower than the average return of the whole South African general equity category.

Source: CoreShares, Morningstar

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