Consistently outperforming peers is hard because while skill plays a role in success, so does luck. This is true whether we’re talking about sports, where the ball needs to bounce in your favor, or active management in the stock market. The recently released Persistence Scorecard Year End 2021 by S&P Dow Jones Indices provides insights into why advisors and end clients have shifted toward index-based, broad market ETFs.
While 58% of the 175 active U.S. large-cap mutual funds that were in the top quartile in 2019 maintained their lofty status in 2020, only 6.9% (just 12 funds) continued to do so in 2021. Investors hoping for a repeat performance were better off if they focused on large-caps that were in the top half of the investment category in 2019, as 29% still outperformed two years later, but most failed to deliver.
In S&P Dow Jones Indices’ analysis, the number of funds included is low, as the analysis avoided double counting multiple share classes by using data on the share class with the highest previous period return.
Not surprisingly, broad market large-cap index-based ETFs, including those tied to the S&P 500 Index, such as the iShares Core S&P 500 ETF (IVV ), the SPDR S&P 500 ETF (SPY ), and the Vanguard S&P 500 ETF (VOO ), as well as those tied to other benchmarks, like the iShares Russell 1000 ETF (IWB ) and the Vanguard Large Cap ETF (VV ), have gained traction in recent years.
There’s a long-held belief that active management should be more successful in the land of small-caps, as some teams have the ability to find hidden gems among the more moderately sized and less-followed securities. However, the data does not back this belief up.
Indeed, while 57% of the 122 top quartile U.S. small-cap funds in 2019 repeated their success in 2020, a miniscule 0.8% (just one) could claim the crown in 2021. The math is somewhat better when broadening out the universe to top half performers from 2019, as 9.4% of these funds were ahead of the peer average, but still nearly nine in 10 small-cap funds were unable to outperform for three consecutive years.
Small-cap ETFs, including those tied to the S&P Small Cap 600 Index, such as the iShares Core S&P Small Cap ETF (IJR ), the iShares Russell 2000 ETF (IWM ), and the Vanguard Small-Cap ETF (VB ), have swelled in size over the years as advisors seek out alternatives to active equity mutual funds.
With all of this data supporting using broad market index-based products for U.S. equity exposure, you might be wondering whether I am the same person who wrote on this platform about the potential in general for active equity ETFs and more narrowly constructed thematic ETFs in recent weeks. To answer: Why yes, I am, and I appreciate you reading my content.
Advisors can build portfolios that combine low-cost core equity exposure using some of the above products with active and/or thematic ETFs such as the ARK Innovation ETF (ARKK ) and the JPMorgan Equity Premium Income (JEPI ), in an effort to generate stronger potential returns, while mitigating the risk of possible underperformance through diversification benefits.
Active and index ETFs can work together to help advisors and their clients strive for outperformance in a risk-managed way.
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