Modern Portfolio Theory tells us that higher returns tend to be associated with higher risk. While our SPIVA Scorecards typically show that active funds underperform their benchmarks in absolute returns, they do not address the claim that active funds may be superior to passive investment after adjusting for risk.
As an extension of the standard SPIVA Scorecard, the Risk-Adjusted SPIVA Scorecard assesses the risk-adjusted returns of actively managed funds against their benchmarks on both a net-of-fees and gross-of-fees basis. We consider volatility, calculated through the standard deviation of monthly returns, as a proxy for risk, and we use return/volatility ratios to evaluate performance.
In the past decade in U.S. equity markets, the S&P 500® gained 257%, with positive total returns in 9 of 10 years and 86 of 120 months. However, these steady tailwinds did little to boost the case for active fund managers. After adjusting for risk, the majority of actively managed domestic funds in all categories underperformed their benchmarks on a net-of-fees basis over mid- and long-term investment horizons.
The risk-adjusted performance of active funds obviously improves on a gross-of-fees basis, but even then, outperformance is scarce. Only Real Estate (over the 5- and 15-year periods), Large-Cap Value (over the 15-year period), and Mid-Cap Growth funds (over the 5-year period) saw a majority of active managers outperform their benchmarks. Overall, most active domestic equity managers in most categories underperformed their benchmarks, even on a gross-of-fees basis.
As in the U.S., the majority of international equity funds across all categories generated lower risk-adjusted returns than their benchmarks when using net-of-fees returns. On a gross-of-fees basis, only International Small-Cap funds outperformed on a risk-adjusted basis over the 10- and 15-year periods.
When using net-of-fees risk-adjusted returns, the majority of actively managed fixed income funds in most categories underperformed over all three investment horizons. The exceptions were Government Long, Investment Grade Long, and Loan Participation funds (over the 5- and 10-year periods), as well as Investment Grade Short funds (over the 5-year period).
However, unlike their equity counterparts, most fixed income funds outperformed their respective benchmarks gross of fees. This highlights the critical role of fees in fixed income fund performance. In general, more active fixed income managers underperformed over the long term (15 years) than over the intermediate term (5 years).
On a net-of-fee basis, asset-weighted return/volatility ratios for active portfolios were higher than the corresponding equal-weighted ratios, indicating that larger firms have taken on better-compensated risk than smaller ones. On an equal-weighted measure, all domestic equity categories underperformed over all investment horizons, except for Real Estate Funds over the five-year horizon.
However, on an asset-weighted measure, over the five-year period, Real Estate, All Mid-Cap, All Small-Cap, Mid-Cap Growth, and Small-Cap Growth funds outperformed their benchmarks. Large-Cap Value funds was the only category that generated higher asset-weighted return/volatility ratios than the benchmark over the 15-year period.
Most fund categories produced higher return/volatility ratios than their benchmarks, gross of fees, on an equal-weighted basis. However, their outperformance diminished once fees or fund size were accounted for, especially in domestic and international equity funds. In general, equal-weighted return/volatility ratios improved more than the corresponding asset-weighted ratios when fees were ignored, indicating that fees play a more prominent role in smaller funds’ performance.
