The Difficulty of Remaining on Top

S&P Dow Jones Indices are market leaders in research and most people will be familiar with their SPIVA Scorecards which they release twice a year.  SPIVA is an acronym for S&P Indices versus Active and the scorecard measures how many active funds outperform their logical benchmark.  What people remember is that it is always a small minority that outperform, a minority that shrinks as one increases the time horizon.

What people may be less aware of is that SPIVA also produce an annual Persistence Scorecard which measures how often the outperformers continue to outperform.  The 2024 Persistence Scorecards were recently released, and the results continue to reaffirm the robust trend from prior years..

SPIVA starts the 2024 US Persistence Scorecard with the following opening paragraph: “Our SPIVA® Scorecards show that most active managers underperform most of the time, especially over the long term.  But on the rare occasions when active managers do outperform, how do we know whether the outperformance was driven by skill or luck?”

What they did find in their analysis was that among top-quartile funds within all reported active US domestic categories as of December 2020, not a single fund remained in the top quartile over the next four years.

If the measurement was changed to be more lenient – how many top half funds remain in the top half over the next 4 years?  Out of the 1 021 funds that were in the top half for the year ended December 2020 only 4.21% remained in the top half over the full period.     

As one can see from the data the drop off happens within a couple of years.  Which means that those funds that had a great 2020 struggled in 2021 & 2022.

So, with the best performers underperforming in future periods would you be better suited to selecting a fund that has had recent underperformance?  This won’t necessarily win either as the Persistence Scorecard also looks at survivorship.  In their data they found that in almost every category, the worst-performing quartile saw the highest proportion of funds that were subsequently merged or liquidated.

Why Active Fund Managers Struggle with Persistence

There could be a number of different reasons why outperformance isn’t lasting however we can just focus on some of the key ones.

Market Cycles and Economic Shifts

Financial markets are inherently cyclical, with different sectors and investment styles performing well at different times.  A fund manager who excels in one market environment may struggle when conditions change.  For example, growth-focused managers may thrive in bull markets but underperform during downturns.

Trades can take a long time to complete

Fund managers generally have a fixed price that they wish to buy and sell at.  Large trades however can impact market prices, so they often spread purchases over time to avoid disrupting the stock price.  This is a consequence of the bid-offer spread.  The spread often has orders on both sides that are well away from the current trade level.

Mean Reversion in Returns

Exceptional performance in one period often leads to mean reversion, where returns normalise over time.  Funds that outperform significantly may have benefited from temporary factors, such as sector momentum or favourable macroeconomic conditions, which are unlikely to persist.

Competition and Arbitrage

The financial industry is highly competitive, with thousands of managers analysing the same data and trends.  Any successful strategy is quickly identified and replicated, reducing its effectiveness over time.  As a result, maintaining an edge becomes increasingly difficult.

Fund Size and Liquidity Constraints

As funds grow in size, their ability to execute nimble trades diminishes.  Large funds often struggle with liquidity constraints, making it harder to capitalize on smaller, high-growth opportunities.  This can lead to performance deterioration over time.

Behavioural Biases and Decision-Making Errors

Even experienced fund managers are susceptible to behavioural biases, such as overconfidence and herd mentality.  These biases can lead to poor investment decisions, particularly in volatile markets, further reducing the likelihood of sustained outperformance.

Fee Structures and Cost Drag

Active management comes with higher fees compared to index-based investing.  Over time, these fees erode returns, making it harder for funds to consistently outperform benchmarks.  Investors increasingly recognize this challenge, leading to the continued shift toward passive strategies.

Conclusion

The SPIVA 2024 Persistence Scorecard reinforces the notion that sustained outperformance in active management is rare.  While some managers may achieve short-term success, maintaining a top-quartile position over multiple periods is exceptionally difficult due to market cycles, competition, behavioural biases, and structural constraints.  Investors should remain cautious when selecting actively managed funds, recognizing that past performance is rarely a reliable indicator of future success.

Magwitch Offshore is a leading provider of Global Balanced ETF portfolios with products in all major currencies. Magwitch utilises an advisor distribution model and their portfolios are available through offshore endowment structures provided by some of the larger Insurers.