A look at the data suggests even less-efficient markets are unyielding for active managers
Traditionally, stock pickers have been able to exploit opportunities by looking for an edge in their chosen markets and positioning their portfolios appropriately. But in the age of the internet when information spreads far and fast, finding that advantage has become increasingly difficult – for both efficient and inefficient markets.
In a blog post published by the CFA Institute, Nicolas Rabener, _ at Factor Research, described how his firm investigated fund managers’ ability to derive alpha within U.S. markets. Looking at S&P’s SPIVA scorecards, they found that 82% of U.S. large-cap mutual fund managers failed to beat their benchmark over the decade ended in 2020. Over the 20 years up to 2020, that record worsens to 94%.
“US small-cap fund managers did not fare much better: 76% underperformed their benchmark over the last 10 years, despite all the hidden gems,” he said, adding that the rate of underperformance was the same for REIT fund managers in the U.S.
To explore the possibility of better fund manager performance in developing markets, where there’s less regulation, more uneven dissemination of information, and higher retail investor participation, Rabener said his firm compared S&P SPIVA data for equity mutual fund managers from emerging markets and those from developed markets.
They saw benchmark underperformance among 74% of developed-market fund managers – including 91% from Canada, marking the worst record – in the three-year period leading up to 2020. In contrast, developing-market managers were only marginally better with 73% benchmark underperformance.
“Unfortunately, extending the observation period does not improve the perspective,” he added. “Mutual fund managers in emerging markets performed slightly worse than their counterparts in developed markets.”
Looking back five years from 2020, 84% of emerging-markets managers lagged their benchmarks, compared to just 80% for managers in more advanced markets. Based on a 10-year lookback, 85% underperformed in emerging markets in contrast to 82% in developed markets.
And while a look at S&P’s performance consistency data shows that the top quartile of emerging market funds from 2016 tended to maintain their standing the following year, only a small percentage are able to survive in the top 25% by 2020.
Taking the exercise further, he compared the HFRX EM Composite Index, which tracks the performance of emerging-market hedge funds, with the MSCI Emerging Market Index. While the hedge-fund index displayed lower return volatility over the period from 2012 to 2020, it’s generally shared the same performance trends as the MSCI index.
“Management fees reduce alpha, to be sure, but the primary reason is that stock picking is simply difficult, regardless of the market,” Rabener said. “There might be more alpha opportunities in emerging markets, but there is also more risk. … Fortunes change quickly in emerging markets where stability is less assured, which makes forecasting futile.”
