Tuesday, April 16, 2013

New Study Comparing Indexed and Actively Managed Funds

By Tim Dulaney, PhD and Tim Husson, PhD

NerdWallet, a San Francisco based personal investing site, has performed a historical study of the returns on almost 8,000 mutual funds and ETFs over a ten year period and found that passive indexed funds tend to outperform actively managed funds on average.  In fact, they found that only 24% of actively managed funds outperformed the average return of the indexed funds.  These results are consistent with the annual SPIVA Scorecard produced by S&P Dow Jones Indices, which found in both 2012 and 2011 that mutual funds tend to have lower returns than their benchmarks.*

Interestingly, NerdWallet also found that before fees the actively managed funds did have higher returns over the period, but that they "charge more in fees than the value they create."  They also found that actively managed funds had lower risk (as measured by the annualized volatility of quarterly returns), and that the risk-adjusted returns of passive and active funds were, on average, nearly the same.**

SOURCE:  NerdWallet

The study also notes that they restricted their sample to the 7,943 mutual funds and ETFs available to US investors for the entire 10 year period between January 1, 2002 and December 31, 2012.  This leads to a selection bias because funds that failed during that period--which presumably realized low returns--are excluded.  In their words, "this survivorship bias implies that index fund returns are even more superior to active fund returns than the numbers indicate," though it is not necessarily the case the more actively managed funds failed with low returns than indexed funds.  This analysis also excludes any fund with an inception date after January 1, 2002, and therefore excludes most ETFs.

While these results are more superficial than those of the SPIVA analysis, this study contributes to growing sentiment that active management may not be preferable to passive index investing.  Indeed, even CalPERS, one of the largest pension funds in the US, may be switching its entire $255 billion portfolio to non-actively managed investments.  It will be interesting to see if this trend towards index investing will continue.
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* This study has a number of drawbacks not present in the SPIVA study, including survivorship bias and a fixed observation period.
**  Unfortunately, the study did not report the variance of its measurements nor statistical significance.

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