Why active funds may not be worth their fees

Recent studies show actively managed funds are not able to outperform their benchmark after fees

Illustration by Sara Sen
Illustration by Sara Sen

IN the current difficult markets, the majority of actively-managed funds have been unable to outperform their benchmarks both in the short term and in the long term, raising the question, are these funds worth the fees they charge investors?

While comparing the merits of investing in actively-managed funds and investing in passively-managed funds is an on-going debate, new studies conducted by the S&P Dow Jones Indices (S&PDJI) indicate that actively-managed funds have consistently underperformed over three-year and five-year periods, and even longer.

Although the SPIVA Australia 2017 “Year End Scorecard” and “Australian Active Funds Persistence Research” are focused on Australian funds, similar studies conducted in Europe, US, Asia and Latin America have yielded the same results.

“The overall conclusion we have come to, is that no matter where the funds are from, the majority of actively-managed funds are still not able to outperform their benchmark after fees. That is the message behind the survey, and we try to make sure people are aware of it,” says Priscilla Luk, managing director and head of Asia-Pacific, Global Research & Design for S&P Dow Jones Indices, in an interview with The Asset.

Luk, who conducted the SPIVA Australia 2017 survey, says investors have a right to expect that actively-managed funds should be able to outperform their benchmarks because these investors pay management fees of about 0.5% and 2% of assets. Luk oversees the SPIVA survey for Australia and Japan while her other colleagues do the survey for the US, Europe, and Latin America.

“When we do the analysis for the comparison of actively-managed funds versus the benchmark, we find that in the one-year or three-year time horizon some active funds are able to outperform the benchmark. But if you look at them in the long-term, like five-year to 10-year periods, the majority of the funds are not able to deliver a better return than the benchmark,” Luk says.

The consistent underperformance of actively-managed funds over long periods, when compared to their benchmark, has raised the issue of whether active fund managers are worth the fees that they charge investors.

“Investors pay the fees and they expect the performance of actively-managed funds to be more or less better than the benchmark if they’re not beating it. But based on the SPIVA survey, the outcome is that actively-managed funds did not outperform after fees or even before fees for some of the categories,” Luk says.

The study has taken into account the fact that the markets have been challenging during the review period.

“What we noticed is that when the market is in a steady uptrend or downtrend, the actively-managed funds have been able to pick up high beta and low beta stocks in a way that outperformed the market. But over the last few years, we have seen that whenever the trend has been up and down, especially in Asia, actively-managed funds do not outperform their benchmark. In Asia, we have seen these in all active funds no matter if they’re large-cap, mid-cap, small-cap, or international equity stake. They haven’t been able to outperform the benchmark,” Luk says.

According to SPIVA, only a minority of Australian actively-managed funds persisted in outperforming their respective benchmarks or consistently stayed in their respective top quartiles for three consecutive years, and even fewer maintained these traits consistently for five consecutive years.

Over two successive three-year and five-year periods, the majority of actively-managed funds failed to beat their respective benchmarks, and most funds in the top quartile did not remain there consistently.

Only 1.1% of the actively-managed funds in 2013 maintained a top-quartile rank over the subsequent four consecutive years, and only 1.0% of funds consistently beat their benchmarks over five consecutive years across all fund categories.

The Australian Bonds category had the lowest turnover in the top quartile, while no funds in the Australian Equity General, International Equity General, or Australian Equity A-REIT fund categories managed to stay in the top quartile over a consecutive five-year period.

Apart from the Australian equity general category, not a single fund from the other categories managed to outperform the benchmark consistently over five consecutive years.

Overall, results from various evaluation matrices suggest weak performance persistence for top-performing funds in Australia across three-year and five-year periods.