Managed Funds Versus Index Funds

Managed or index funds: it’s an often-held debate between investors. And to a certain extent the decision as to which one is “best” will come down to personal preference. That said, it’s always worth looking at some statistics…

In February this year, the S&P Dow Jones released their SPIVA Australian Scorecard for the end of 2016. This regular scorecard reports on the performance of actively managed Australian managed funds versus the relevant benchmark index for each of those funds. Here’s a quote directly from that report:

“In 2016, the majority of Australian funds in all categories underperformed their respective benchmarks. There is no consistent trend in the yearly active versus index figures, but we have consistently observed that the majority of Australian active funds in most categories fail to beat the comparable benchmark indices over long-term horizons.”

Despite the report stressing that the index vs active debate “has been a contentious subject for decades”, the report is being used by many as evidence for the supposed inefficiency of active funds and superiority of passive index funds.

The report notes that while the S&P/ASX 200 saw an increase of nearly 12% in 2016, Australian large-cap equity funds only managed to average a 9.2% increase.

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Managed funds vs index funds: The results

Here are some findings from the SPIVA ScoreCard concerning the Australian market:

  • Out of all Australian equity general funds:
    • 69.88% underperformed against the S&P/ASX 200 on a 5-year basis
    • 67.76% underperformed against the S&P/ASX 200 on a 3-year basis
    • 76.38% underperformed against the S&P/ASX 200 on a 1-year basis

 

  • Out of all Australian Equity Mid- and Small-Cap funds:
    • 48.00% underperformed against the S&P/ASX Mid-Small Index on a 5-year basis
    • 61.86% underperformed against the S&P/ASX Mid-Small Index on a 3-year basis
    • 81.73% underperformed against the S&P/ASX Mid-Small Index on a 1-year basis

 

  • Out of all Australian Bond funds:
    • 77.36% underperformed against the S&P/ASX Australian Fixed Interest 0+ Index on a 5-year basis
    • 90.20% underperformed against the S&P/ASX Australian Fixed Interest 0+ Index on a 3-year basis
    • 62.96 underperformed against the S&P/ASX Australian Fixed Interest 0+ Index on a 1-year basis

 

  • Out of all Australian Equity A-REIT (real estate investment trusts) funds:
    • 83.33% underperformed against the S&P/ASX 200 A-REIT Index on a 5-year basis
    • 92.86% underperformed against the S&P/ASX 200 A-REIT Index on a 3-year basis
    • 77.14% underperformed against the S&P/ASX 200 A-REIT Index on a 1-year basis

So what’s the take-away message?

The common-sense conclusion that can be drawn from SPIVA’s findings is that passive funds are likely to out-perform their managed counterparts, making them a safe and prudent addition to anyone’s portfolio.

Take it from Nobel Prize winner William Sharpe, who said, “Properly measured, the average actively managed dollar must underperform the average passively managed dollar, net of costs.”

That being said, it’s important to keep in mind that past performance isn’t a guarantee of future return, and future years may see a trend of high return among managed funds.

If you did want to take a look at what is available in the market for managed funds, we have provided a comparison table below for Multi-Sector Moderate Funds for an investment amount of $50,000. This table is sorted by our star ratings (H-L).

If you’ve got your heart set on active managed funds

If you’re keen to put your money in an active managed fund, the current numbers suggest that you’re best-off investing in a small- or mid-cap fund, as they’ve historically provided the best returns among managed funds.

Remember to consider fees and not just return when it comes to active managed funds, because no matter whether they make a profit or a loss for you, the fund managers want their salary. Actively-managed funds tend to charge higher fees for the privilege of hand-selected investments, along with more staff, more analysis, and more active trading to pay for. It’s a shame that all that activity often doesn’t result in a better performance!

There will always be those who are convinced they have superior investment-picking skills. Very occasionally they’ll be right. So there will always be a place for active managed funds, no matter what the cost and average under-performance.

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This general advice has been prepared by Canstar Pty Ltd A.C.N. 053 646 165, Authorised Representative no 443019 of Canstar Research Pty Limited A.C.N. 114 422 909 AFSL 437917. The information does not take into account your individual investment objectives, financial circumstances or needs. Consider whether this advice is right for you. You may wish to obtain financial advice from a suitably qualified adviser before making any decision to acquire a financial product. Refer to the PDS before making a purchase decision. Read Canstar’s Financial Services Guide (FSG) here.

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