2023 SPIVA Results: The Good, Bad, and Ugly for Active Management

The good: small-cap value, fixed income

The latest SPIVA report provides a segmented performance analysis, with large-cap funds, for instance, benchmarked against the S&P 500. However, two segments stood out for their performance.

Firstly, small-cap value, a popular factor combination, showed that over the trailing 1, 3, and 5 years, only 36.84%, 49.32%, and 62.14% of all funds underperformed the S&P SmallCap 600 Value Index, respectively.

My expectation is that underperformance rates may decrease as firms like Avantis Investors and Dimensional Fund Advisors release more cost-efficient factor ETFs, such as the Avantis U.S. Small-Cap Value ETF (

), which has an expense ratio of 0.25%.

The second area where active excelled was in global fixed income. Here, 1, 3, and 5-year underperformance rates against the iBoxx $ Overall Index were low at 31.25%, 32.50%, and 45.45%, respectively.

Fixed income is an area where active management can add significant value due to its less liquid, more opaque nature, and the various levers managers can pull, such as duration and credit quality. An example of success in this field is the PIMCO Active Bond ETF (

), a mainstay in active bond ETFs that has consistently outperformed its index.

Short-term bonds also show promise for narrowing performance gaps, especially as newer active ETFs like the JPMorgan Ultra-Short Income ETF (

) offer competitive expense ratios as low as 0.18%, aligning closely with older index products.

The bad: Large-cap growth

In the SPIVA report, the large-cap growth segment particularly caught my eye. It noted that over the trailing 1-year period, only 9.76% of all funds underperformed the S&P 500 Growth Index. At first glance, this seems impressive. However, the picture changes drastically when you look at the 3-year results, where 72.10% of funds underperformed.

This significant gap can likely be attributed to the recent bull market, driven by the outstanding performance of mega-cap growth stocks. In such an environment, it's easy for the line between genuine skill (alpha) and simply riding the market wave (excess beta exposure) to blur. Funds that heavily overweighted the "magnificent seven" stocks and maintained a focused portfolio generally came out on top.

However, over the long term, factors like drawdowns and volatility play crucial roles. The difference between the one and three-year performance gaps can be traced back to the 2022 bear market, during which many large-cap growth funds faced substantial losses. This highlights the importance of considering longer-term performance and risk management, rather than short-term gains.

The ugly: Large-cap value

The large-cap value segment in the SPIVA report presents a rather ugly picture: funds consistently lagged behind the benchmark across all examined time frames.

The underperformance rates of large-cap value funds against the S&P 500 Value Index were 90.77%, 93.86%, 92.92%, 92.77%, and 93.77% for the 1, 3, 5, 10, and 15-year periods, respectively.

Interestingly, this was one of the few segments where the rate of underperformance did not decrease in shorter time frames, indicating that active managers face difficulties in outperforming the benchmark, regardless of the period analyzed.

This consistent underperformance, both short and long-term, suggests a challenging environment for active management in this space. I think the difficulty in generating alpha in the large-cap value segment can be attributed to its highly scrutinized and crowded nature.

Blue-chip companies like Procter & Gamble and Johnson & Johnson are so extensively covered and analyzed that finding undervalued opportunities is incredibly challenging. Moreover, any potential alpha is likely eroded by management fees, particularly over extended periods.

While large-cap value investing remains a cornerstone of many portfolios, the SPIVA results suggest that indexing might be the more prudent approach in this segment. On the other hand, the small-cap value segment appears to offer more fertile ground for active strategies to outperform, as indicated by the report's findings.

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.