Small and mid-cap funds struggle to outperform benchmarks: Report

Aye Soe, S&P Global Head of Product Development, joined Yahoo Finance Live to discuss S&P Dow Jones Indices' biannual SPIVA U.S. Scorecard.

Video transcript

- I think it's fair to say that a lot of us consider Warren Buffett one of the greatest investors of all time but right now he's doing a happy dance because although he's one of the greatest investors of all time, he often advised those of us lesser mortals, to consider passive investing because he has pointed out that the expense of money managers, rarely did they honor regular basis beat the S&P 500.

Why take it from Warren Buffett? Let's take it from the data itself and then write into the program. Aye Sore, S&P Global head of product development, who along with Mr. Buffett, may be doing the happy dance right now. it's, good to have you here. And essentially, your latest scorecard looked at the results of money managers and, well, what did you find?

AYE SOE: Well, we've been publishing the scorecard since 2001 and the findings have been pretty consistent. For the year ending June 2021, we found that the majority of active managers in the large-cap space underperformed the benchmark, so in this case is S&P 500. 58% underperformed the S&P 500, 75% of mid-cap managers underperform S&P mid-cap 400, and then 78 underperform the small-cap benchmark. So that is pretty incredible in the small cap space.

- Certainly is pretty incredible. When it comes to, I guess, how investors should approach this, is there any reason why you should favor an active manager over the passive alternative?

AYE SOE: The data is pretty compelling when you look at our study because we've been publishing it since 2001. So the report has gone through financial crisis, recessions, pandemic and the results, when you look over the long term investment horizon, are pretty consistent. That is the majority of active managers have a very difficult time beating the passive benchmarks.

Not only that, they have a hard time beating, when you look at the top performers, they don't stay in the top quartile consistently from year to year. So you might get lucky this year and be the benchmark but that doesn't mean you'll be the benchmark come next year. So the data is very compelling in ensuring that it's difficult to beat the benchmark over the long run.

- I don't want to get too wonky here but are you able to extrapolate, from the data, the mistakes that the managers who are not beating the index might be making? Are they trying to time markets, is it something that's identifiable?

AYE SOE: I think market timing, it is very difficult to time the market because we do not know when the rotation or the recycling from one style to the other would take place. For example, I will point out last year, at the beginning of last year, to all the way through September really favored the large-cap managers or the large-cap stocks and investors or active managers investing in those large-cap stocks did better.

But come this year when there is rotation into smaller-cap or more cyclical names, we find that those holding on to large cap names or larger cap names tend to lag the benchmark. So it very difficult to tank the market over the long run because you do not know when the rotation will take place.

- How about US markets versus foreign markets? Is the data consistent just in terms of what we're finding about what makes the most sense or does it vary a little bit when we start to look overseas?

AYE SOE: Even overseas if you divide into developed markets or emerging markets, we find that it is also equally difficult to outperform the benchmark over long term investment horizon, and that dispelled summits because we always assumed that emerging markets are inefficient and it's easier to access via active management, but the data shows otherwise.

- I can't remember the article but a while back they looked at the different performance of funds that were managed by women versus funds that were managed by men. Do you have that data? Do the women tend to outperform the men? Because I think that article was saying that men tend to be more risky with other people's money than the female fund managers. Is there data on that?

AYE SOE: We don't have that data but I have seen articles that-- or the studies that show that. I think we need to look at it not only over short term but over medium to longer term to make definitive statements like that, yes.

- Aye, where should investors be putting their money right now? You were saying don't base hit on past performance because even if you were to go the active manager route a lot of times, maybe they'll beat the index one or two times but that doesn't necessarily lead to a trend. So what are you advising, or what would your advice to investors be?

AYE SOE: I think I really urge the investors to do their, you know, to do the homework. And index providers like us, we publish intensive, in-depth studies on the performance of active funds versus passive. I do point out to one thing, we very recently released a research paper that looked at the index tied to passive investing, which is along to S&P 500. Over 5.4 trillion directly tracks S&P 500.

During that period of time, we also take a look at the amount of savings that investors will gain from tracking passive funds versus active funds, where we look at the fee difference and apply it to the index assets. And we find that over 25 years, investors would have saved over $357 billion in fees, or in dollar terms, just by pursuing the passive investment. The number is astounding, $357 billion in savings gained from passive investing alone, over active.

- I have an annual dinner with a bunch of guys I've known since I was just a kid. I'm inviting you to join me because they are money managers, and they beat me up all the time when I say, look, I do it passively. I'm not going to have the returns you get, but I think I'm going to beat you in the long run. And you just made my case. So Aye Soe, you got a dinner invitation if you can put up with those loud mouths I hang out with.

Aye Soe, by the way, is the S&P Global Head of Product Development. It was good to have you here. A lot of people listening to that advice because many of us are passive investors.