Many investors have likely heard the adage that active management performs better in times of market turbulence. This may sound like an emotional hedge for market stress akin to betting against your favorite sports team to balance an adverse outcome with financial compensation. However, a historical analysis of active US-domiciled equity funds finds no meaningful relation between market volatility and managers’ success rates; the implication is that traditional active investments may compound your concerns during times of market uncertainty.
The rolling three-year standard deviation for US stock market returns, illustrated by the orange line in Exhibit 1, shows recent volatility has been at its highest since the 2008 financial crisis. Whether this portends success by active managers is doubtful. The rolling three-year outperformance rates by active US equity funds (blue bars) imply very little relation with volatility levels. The year-to-year variation in success rates does not consistently track market volatility. For example, rolling averages of daily volatility from 2014 to 2019 were consistent in level and yet the percent of funds outperforming during these rolling periods was not, ranging from 23% to 37%.
Volatile market environments give us enough to worry about. Investors can do without unpredictable outcomes from traditional active management.
See related article – Broker/Advisor Outperformance?
“We instead focus on designing properly diversified, low costs, and tax efficient portfolios that specifically align with our individual clients’ risk tolerance and goals. Those portfolios help our clients enjoy risk based long term market returns, which along with their individualized comprehensive financial planning, provide them the greatest probability of achieving the wealth they seek to enjoy.”
Alfredo Mesa CFP®
Mesa Financial Group, LLC
By Wes Crill, PhD
DFA Head of Investment Strategists and Vice President
Active management: A portfolio management approach that aims to outperform a market rate or return, or a specific benchmark, by choosing investments that deviate from the market portfolio or benchmark.
Standard deviation: A measure of the variation or dispersion of a set of data points. Standard deviations are often used to quantify the historical return volatility of a security or portfolio.
Fama/French Total US Market Research Index: The value-weighted US market index is constructed every month, using all issues listed on the NYSE, AMEX, or Nasdaq with available outstanding shares and valid prices for that month and the month before. Exclusions: American depositary receipts. Sources: CRSP for value-weighted US market return. Rebalancing: Monthly. Dividends: Reinvested in the paying company until the portfolio is rebalanced.
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