SAN FRANCISCO -- The average active U.S. equity manager underperformed the S&P 500 by 0.5 to 1.2 percentage points between 1987 and 1997, according to a new report commissioned by Barclays Global Investors.
In the institutional sector, the average U.K. active manager also underperformed the Financial Times-Stock Exchange All Share Index in all but three years. Comparing large-cap U.K. indexed funds with active U.K. equity funds, large-cap active managers underperformed indexed managers by an average of 0.6 percentage points per annum from 1987 to 1997, according to the report.
On the retail side, active large-capitalization U.S. managers underperformed indexers by 0.5 percentage points per annum, while their U.K. counterparts underperformed index managers by 1.7 percentage points per annum between 1987 and 1997.
But active small-cap managers and active international equity managers have outperformed.
In the small-cap area, actively managed U.S. small-cap stocks outperformed the Russell 2000 index by an average of 2.4 percentage points between 1993 and 1997, the report noted. In the United Kingdom, the median small-cap active manager outperformed the market by an average of 2.2 percentage points, the report stated.
In the small-cap U.S. retail markets, active managers outperformed index managers by 3.6 percentage points per annum in the period from 1987 to 1997. There were no comparable figures given for the small-cap U.K. retail sector.
"The data would suggest in the small-cap area, the average small-cap active manager outperforms the indexes, but the data is not all there," said Jim Creighton, chief investment officer in charge of global indexing.
While there is a wealth of data for large-cap funds, there is no comparable data in the small-cap and midcap realms, he said.
"There's a lot of style drift," Mr. Creighton said. "Midcap managers hold large-cap stocks and it is difficult to interpret the data."
According to the report, large-cap stocks have overperformed midcap equities. Between 1987 and 1997, the Standard & Poor's 500 stock index grew at a rate of 17.6 percentage points per year as compared with 14.7 percentage points per year for the Russell 2000.
The other issue in the midcap and small-cap worlds is that information on survivorship bias, in which an underperforming portfolio may be closed and the assets merged into a better-performing portfolio, is incomplete. At that point, the data for the poorly performing portfolio disappears When you look at the results over a 10-year period, survivorship plays can make fund returns artificially high, Mr. Creighton explained.
Estimates of the impact on returns of survivorship bias for U.S. large-cap mutual funds is from 20 to 150 basis points, according to the report summary. At the institutional level, the data indicates survivorship bias to be about 60 basis points over a 10-year period, so the report adjusted for survivorship bias of 50 basis points.
"One can make a cogent argument that survivorship is at least twice as high for a mid- and small-cap fund or higher than that," Mr. Creighton said. "The logic is simple. Small cap is more volatile than large cap. There's a difference of 20% between best and worst."
So, he continued, if the worst performing funds are dropped off the records, then only the best performers remain.
On the institutional side, active fund returns lagged the S&P 500 between 1.2 and 0.8 percentage points, depending on the source of the data used. According to information provided by Lipper Analytical Services, New York, for the study, U.S. institutional large-cap active managers underperformed the benchmark by 1.2 percentage points; data from Callan Associates Inc., San Francisco, indicate the underperformance was 0.8 percentage points.
After taking management fees and transaction costs into account, passive managers outperformed active managers by another 0.75 percentage points for the U.S. large-cap institutional market and 0.95 percentage points for the U.S. large-cap retail segment for the period of 1987 to 1997, the study's executive summary noted.
According to the report, quoting from a Callan Associates Fee Survey, the cost differential between active and passive equity fund management is around 45 basis points for a medium-size mandate and the range of costs is five times as great for an active portfolio as for an indexed one.
The study concluded that indexing saves U.S. institutional investors between $14 billion and $18 billion annually over active management. The savings come from the average underperformance of active managers, and indexers' lower fees and lower trading costs. The report estimated the accumulated savings since 1973 is between $80 billion and $105 billion.
In the United States, an estimated 23% of all equity mandates are under index management. In the United Kingdom, about 20% of equity mandates are indexed.
From 1987 to 1997, the summary states, indexing has saved U.S. investors between $80 billion and $105 billion.
Much of the growth in indexing has been in the tax-exempt institutional segment, where 13% of assets is under management. On the retail side, less than 5% of assets are indexed.
However, PricewaterhouseCoopers, which conducted the study for BGI, had difficulty collecting data from institutional investors. The full report, which assesses the costs and benefits of indexing in global fund management, focuses on equity markets in the United States and United Kingdom.
