66% of fund managers can't match S&P results

That hot-shot mutual fund manager you’re betting on to make you rich might be generating returns that fall far short of the benchmark stock index the fund tracks.

Last year, for example, when the Standard & Poor’s 500-stock index posted a paltry total return of 1.4% with dividends included, 66% of “actively managed” large-company stock funds posted smaller returns than the index, according to the latest SPIVA U.S. Scorecard released Wednesday by S&P Dow Jones Indices. In Wall Street-speak, that means two out of three fund managers “underperformed” the stock benchmark they are measured against. The longer-term outlook is just as gloomy, with 84% of large-cap funds generating lower returns than the S&P 500 in the latest five-year period and 82% falling shy in the past 10 years, the study found.

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The results were similarly dismal for stock fund managers who run midcap funds and small-company funds, with 57% and 72%, respectively, underperforming their benchmarks in 2015.

The debate over active portfolio management (or a fund run by a real-life stock picker) vs. a so-called passive fund (which simply tries to mimic a stock index and match its returns by constructing a portfolio that basically copies the composition of the index) is not new or novel.

“It has been a contentious subject for decades,” Aye Soe, senior director of index research & design at S&P Dow and author of the latest scorecard on passive vs. active investing, noted in the report.

The debate, in  a nutshell, goes something like this: Why pay higher fees for an actively managed fund that has a shot at posting much bigger returns than the index it’s measured against but which also runs the risk of posting smaller returns, when you can buy a low-cost index fund, such as those that track the performance of the S&P 500 index, which pretty much guarantees that your returns will be in line with the index?

You might get lucky, of course, and latch onto to the hot-hand of a manager like Bill Miller, who from 1991 to 2005 ran a fund at Legg Mason that posted better returns after fees than the S&P 500. Miller, of course, subsequently went cold, and the fund’s performance trailed the S&P 500 for three straight years after his long winning streak.

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But once you add in fees (the average stock fund had an expense ratio of 1.19% in 2014, according to Morningstar’s 2015 Fee Study, vs. 0.17%  for an S&P 500 index fund offered by Vanguard), and consider the unpredictability of the market and other quirks of the money-management business, such as how index gains are calculated, it’s not that easy for portfolio managers to consistently outpace passive funds.

The S&P 500 is a cap-weighted index, which means the returns of the largest companies have the biggest impact on the index’s performance.

In 2015, for example, money managers who did not own the handful of highflying mega-cap stocks, such as video streamer Netflix, which jumped 124%, Amazon.com, up 118% and Google parent Alphabet, which rallied nearly 47%, had a tough time keeping up with the index, says Thomas Lee, founder of investment research firm Fundstrat Global Advisors.

“It was a tough year for active managers because of the outperformance of mega-caps in 2015,” Lee told USA TODAY. “The median stock (and average stock) did worse than the S&P 500 overall.” The big leadership shift away from biotechs also hurt fund managers who were overly exposed to the once-hot sector, he adds, as did having too big a helping of hard-hit energy stocks.

Higher fees for actively managed funds also played a role.

“Fees explain a lot of the long-term underperformance” of actively managed funds, Lee says.

Adam Shell on Twitter: @adamshell.