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'Bearly' Winning

Active managers haven't done much better than their benchmarks during the bear market.

Daniel Culloton, 03/03/2009

This is the big one; a bear market so fierce and unrelenting that it'll expose index funds for the dumb investments they are and allow active managers to show their quality.

Or maybe not.

I recently looked at how actively managed funds have fared versus similarly styled benchmarks thus far in this the worst stock market crash since the Great Depression. What I saw probably won't end up in any actively managed fund's marketing materials. While the typical active manager has beaten certain benchmarks from when the major market averages peaked on Oct. 9, 2007, through the end of January 2009, the victory hasn't been clear-cut. Also the typical stock-picker's inability to beat the Standard & Poor's style benchmarks in most categories undercuts the argument that active managers would hold up better in a severe downturn by favoring so-called higher-quality stocks.

Pyrrhic Victory
Yes, the average active domestic-stock manager in most categories has lost less than most of their respective Russell and Morningstar U.S. style indexes during the time period. The stock-pickers beat the Russell bogies in six of nine categories--all but large growth, small blend, and small growth. They also defeated the Morningstar benchmarks in seven of nine style box areas--all but large blend and small growth.

And manager discretion may have mattered. The Russell and Morningstar indexes are purely objective. Though their style indexes sort stocks according to value and growth characteristics, they include all stocks in their given universes regardless of whether the underlying companies are profitable (e.g. high quality). That lets in some speculative stuff that could fall harder in bear markets. It also gives active managers a chance to beat the fully invested benchmarks by favoring the higher-quality stocks, or those that tend to be profitable and that have defensible competitive positions, or by holding more cash.

Differentiation Deficit
Overall, though, active managers don't have a lot to crow about. Their margins of victory over the Russell and Morningstar Indexes were meager. (The largest gap was nearly 270 basis points, or hundredths of a percent, out of roughly 4,000 basis points in the mid-cap value category.) As Morningstar vice president of research John Rekenthaler noted after eyeballing the returns, that's not much of a differentiation.

Furthermore, on average most active managers couldn't beat most of the S&P Indexes that impose a rudimentary profitability screen on their constituents to weed out lower-quality stocks. The typical active manager lagged his or her corresponding S&P style index, which each requires candidate companies to have four consecutive quarters of profitability before they are included, in seven of nine categories (all but the large- and small-cap value groups).


 'Bearly' Winning
Average Active Fund by Category
Russell Indexes Index Return
Morningstar Indexes Index Return
US OE Large Blend -37.21 Russell 1000 -37.41 Morningstar Large Core -32.37
US OE Large Growth -36.99 Russell 1000 Growth -35.12 Morningstar Large Growth -37.09
US OE Large Value -38.16 Russell 1000 Value -39.83 Morningstar Large Value -39.48
US OE Mid-Cap Blend -38.22 Russell Mid Cap -40.36 Morningstar Mid Core -39.19
US OE Mid-Cap Growth -40.20 Russell Mid Cap Growth -40.43 Morningstar Mid Growth -41.27
US OE Mid-Cap Value -37.93 Russell Mid Cap Value -40.62 Morningstar Mid Value -40.17
US OE Small Blend -39.11 Russell 2000 -37.90 Morningstar Small Core -39.69
US OE Small Growth -40.96 Russell 2000 Growth -38.59 Morningstar Small Growth -39.60
US OE Small Value -37.31 Russell 2000 Value -37.37 Morningstar Small Value -37.81
Returns are from 10/09/2007 through 01/31/2009.


 'Bearly' Winning
Average Active Fund by Category
Standard & Poor's
Index Return
US OE Large Blend -37.21 S&P 500 -37.10
US OE Large Growth -36.99 S&P 500/Citi Growth -32.43
US OE Large Value -38.16 S&P 500/Citi Value -41.78
US OE Mid-Cap Blend -38.22 S&P MidCap 400 -36.11
US OE Mid-Cap Growth -40.20 S&P MidCap 400/Citi Growth -35.62
US OE Mid-Cap Value -37.93 S&P MidCap 400/Citi Value -36.61
US OE Small Blend -39.11 S&P SmallCap 600 -37.49
US OE Small Growth -40.96 S&P SmallCap 600/Citi Growth -37.74
US OE Small Value -37.31 S&P SmallCap 600/Citi Value -37.46
Returns are from 10/09/2007 through 01/31/2009.

The story in other asset classes wasn't much more cheery for active managers. The typical active taxable-bond fund lost more than 5% from Oct. 9, 2007, through the end of January 2008 while the Barclays Capital Aggregate Bond Index gained 5.74%, a difference of nearly 11 percentage points. No fair, you cry. The broad taxable bond asset class includes high-yield and other riskier funds that bore the brunt of the financial crisis, so a total bond market index, which holds a lot of Treasuries, isn't an appropriate benchmark. Well, the average active fund in the intermediate term bond category, which often peg the Barclays Index as the one to beat, also lost more than 2% during the time period.

Overseas the average actively managed international fund lost a tad more than the MSCI EAFE Index during the time period, about 43% versus 42.9%. The typical active manager in the foreign large-blend and foreign large-value categories were a little better with losses of 42% and 41%, respectively. Foreign large growth was about even with the index. Once again, it wasn't the kind of outperformance you can brag about.

Advantage, Market
There have been individual managers, management teams, and strategies that have limited the damage during this bear market. As the bear market drags on, active managers collectively also could improve their relative standing somewhat. And losing 37.1% in an S&P 500 fund instead of 37.2% in an actively managed large-cap blend fund shouldn't make anyone feel happy. But the average active manager's absolute and relative performance so far makes it hard, to paraphrase Vanguard founder and index fund creator Jack Bogle, for the active funds to claim superiority over the market averages.

Daniel Culloton is senior fund analyst with Morningstar. 

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