If you want to beat the market by picking individual stocks or trying to time your entry and exit points, you may as well flip a coin.
That’s the unequivocal message delivered by a closely followed regular research report issued by S&P Dow Jones Indices, a company that supplies the benchmarks that fund managers around the world use to compare their performances.[1]
For the past 20 years, the ‘S&P Indices Versus Active’ funds report, or SPIVA for short, has become the de facto scorecard in the ongoing ‘active versus passive’ debate.
This debate pitches traditional managers, who sell their ability to pick mispriced stocks and make tactical moves, against those managers who accept prices as broadly fair and who harvest the capital market rates of return at low cost without trying to outguess the market.
So what does the latest survey show? In short, the active camp has lost, again. The survey shows that in the short term it’s close to 50-50 proposition whether active managers beat the benchmark. And the further you go out in time, those odds continue to worsen.
So, what’s been happening on markets? Well, it’s not news that this year so far hasn’t been a vintage one for global shares or for Australian ones. Locally, the S&P/ASX 200 index dropped just under 10% in the first half of 2022; developed markets outside Australia were down about 16% in the first half. Hitting sentiment have been higher-than-expected inflation readings, the withdrawal of stimulus by central banks and the uncertainty created by Russia’s war in Ukraine with its associated impact on energy costs.
But never mind, you might say. These times of volatility are when active managers shine and we’ll just go right out and find the managers who can outperform in tough markets.
Well, guess what? The SPIVA scorecard shows that 49.8% of Australian equity managers in the first half fell short of the benchmark. Over three years, that proportion climbed to 50.3%, over five years to 73.6%, over 10 years to 77.2% and over 15 years to 82.9%.
For international share managers, the numbers were even worse, with 56.9% of managers underperforming the benchmark in the first half of the year, extending to 85.6% over three years, 86.1% over five years, 95.4% over 10 years and 95.0% over 15 years.
The record for active Australian bond managers is worse again. In the half year to June, the toughest period for bonds in decades, 77% of managers underperformed the bond benchmark. Again, that gets progressively worse as the years go on.
What are we to make of this? Firstly, it’s evidence, once again, that beating the market by trying to outguess it is incredibly hard. Not even the paid professionals can do it consistently, if at all. Sure, everyone has an opinion about where the best returns are going to come from next. But that’s all it is – an opinion. As financial advisers whose philosophy is based on evidence we’ve found over the years that “I reckon” is not the basis of a sound long-term strategy for clients.
Secondly, the fact that markets are so hard to beat consistently is a sign of their efficiency. What that means is that news gets priced in instantaneously. You might have a theory that betting on China, or Bitcoin, or high-tech stocks is the path to riches. But the truth is your view and everybody else’s views are already baked into prices.
It’s what happen next that drives returns, and no-one knows what will happen next. Just think back to the beginning of 2020. Everybody’s carefully calculated projections got blown out of the water when the pandemic was declared. Our market fell 37% in five weeks, then bounced back to end the year higher. Good luck trying to predict that sort of price movement.
Thirdly, it’s our strong view at WARR HUNT, based on decades of research and hard evidence, that you don’t need to try to outguess the market to have a good investment experience. The answer is to work with the market instead, using an enhanced asset class investment approach.
This approach is not active in the traditional sense of trying to discover mispricing. But neither is it a purely index approach. It’s a smart, strategic, low-cost and highly diversified approach that systematically targets the long-term drivers of return in equities and bonds.
Portfolios are rebalanced as markets evolve and as client needs’ change. This is not a set-and-forget strategy but one that is active about things we can control and one that ignores the confident pub talk you hear every day about which stocks and sectors are going to shine next.
Don’t get us wrong. We applaud anyone who can go out there and outperform the market year in and year out with smart stock selection and tactical asset allocation. But as you can see, there is little sign that those people exist, even among the fund management professionals.
Ultimately, we base our advice to clients on hard evidence. We insist on a rigorous, empirical understanding of what drives returns and how we can capture them efficiently. And we want a process that is repeatable and defensible.
We think that’s better than a coin toss.
[1] SPIVA Australia, Mid-Year 2022 Highlights, S&P Dow Jones Indices; full article can be found here