Each year, Standard & Poor's release the findings of their SPIVA report (Standard & Poor's Index Vs Active). The report for 2020 is interesting, as we have just been through a very volatile period for share markets.

In February and March last year, we saw share market indices drop by a third around the world. However, they quickly rebounded, with most reaching new highs by the end of the year.

A common claim made by active managers is their ability to outperform during times like these. They claim that while index funds don't do anything while prices fall, an active manager can nimbly jump between investments to save capital.

We have heard this consistently for the last decade, where big downturns were few and far between (especially compared to the decade preceding). So how have these managers fared during their time to shine?

For their SPIVA report, S&P compare the performance of actively managed funds in a variety of countries to their benchmark index. In the US, there were 1,121 funds initially.

If active managers are providing returns in line with the index, we expect less than half to outperform each year due to higher fees. If we see more than half outperforming, the average active manager has added value after fees for that period.

SPIVA for 2020

You can look through the figures for the latest report on S&P's website. Let's start by looking at the 1-year figures to see the performance for 2020. The report is split up by country.

Percentage of active managers underperforming their benchmark in 2020:

• USA - 60.33% underperformed

• Canada - 87.50% underperformed

• Mexico - 69.39% underperformed

• Brazil - 73.14% underperformed

• Chile - 58.97% underperformed

• Europe - 37.27% underperformed

• South Africa - 44.44% underperformed

• India - 80.65% underperformed

• Japan - 54.00% underperformed

• Australia - 55.60% underperformed

This does not paint active management in a favourable light, with particularly poor performance in Canada and India.

Surprisingly, last year brought outperformance in Europe, buoyed by UK managers, possibly due to factor exposures. S&P pointed out how these managers actually suffered losses similar to the index during the first quarter of the year, but delivered higher performance later.

SPIVA over the last five years

Despite good performance last year, it only gets worse for these managers over longer periods.

Percentage of active managers underperforming their benchmark over last five years:

• USA - 75.27% underperformed

• Canada - 98.63% underperformed

• Mexico - 80.00% underperformed

• Brazil - 86.27% underperformed

• Chile - 95.24% underperformed

• Europe - 75.17% underperformed

• South Africa - 60.00% underperformed

• India - 87.95% underperformed

• Japan - 69.53% underperformed

• Australia - 81.70% underperformed

Despite good outcomes in Europe last year, three quarters underperformed over the longer period. We see similar results in the USA and Australia, and Canada again at the back of the pack.

Persistence of returns

If the poor outcomes of the average manager doesn't deter an investor, they may want to try picking the one in five (such as in Australia) that will deliver. However, there isn't any evidence that doing so is possible.

The persistence scorecard adds another question to the SPIVA report: can the percentage of managers outperforming be explained by chance? If we expect some managers to do well due to luck in any given year, we should also expect a few to get lucky year on year.

S&P investigate this by taking the fund managers in the top 50% and check if they stay in the top 50% in subsequent years. If their performance was due to chance, we expect 25% to remain after one year, 12.5% in the following year etc.

In reality, starting in 2016, the results were worse than we would expect by chance. In the US, only 21.4% of managers remained in the top half in the following year. By 2020, only 4.8% stayed consistently in the top half, compared to 6.25% expected by chance.

Clearly it is not possible to choose the better managers based on their past successes.

The evidence supporting passive investment

One of the most important ideas supporting passive management is the Efficient Market Hypothesis, which describes how information is rapidly reflected in share prices. This means that, with so many market participants and information instantly available, all these participants bid the share price to a fair value.

Very few academics or investment professionals believe markets are perfectly efficient, but SPIVA provides evidence that they are efficient enough that active management is not worthwhile.

SPIVA is not the only research which shows this underperformance by active managers. Ken French published his own paper documenting the underperformance of US active fund managers. He found that the aggregate of these managers' portfolios is very similar to the index, yet they underperform due to higher costs. There is no peer-reviewed research paper which supports active management in favour of passive management.

What this means for investors

The takeaway for investors is clear. We should leave active management out of our portfolios and strong past performance does not point to good returns moving forward.

We continue to advocate for Dimensional's funds in our portfolios, as they eschew forecasting and predictions. Instead they focus on wide diversification, lower costs and the things we can control.