Is active management a ‘loser’s game’?

Written by multiforte on . Posted in News

More than 40 years ago, respected US investment consultant, Charles Ellis, wrote an influential paper arguing that active investment management is a ‘loser’s game’. That is, a game that’s possible to win, but where the odds of doing so are so poor, that the winning strategy is not to play.

And yet, many investors continue to be drawn to active investment managers – those that buy and sell shares in the hope of beating the returns of the markets in which they invest.

Now, don’t get us wrong. We have nothing against active fund managers, most of whom are super smart, talented, good people. Our concern is that there are so many of these super smart and talented managers in the marketplace offering investment funds that it’s almost impossible – even for the brightest and best – to consistently outperform their peers.

And this, as counter-intuitive as it may seem, is exactly what the evidence shows.

In this month’s news, we share a just-published scorecard report on the performance of active fund managers compared with their market benchmarks. And we discuss why, even with their smarts and access to market information, it is virtually impossible for these active managers to consistently outperform.

It is rare for an active investment manager to consistently beat the market

When we want to compare the performance of active investment managers versus an index, our favourite report is SPIVA – which stands for S&P Indices Versus Active.

Created and refreshed every six months by S&P Dow Jones Indices, the report accesses an extensive database of investment fund data and then compares funds of a particular type against an appropriate benchmark index. So, for example, it compares the performance of Australian large cap share funds with the S&P ASX 200 index, and International share funds with the S&P Developed Ex-Australia Large Mid Cap Index.

With this report in hand, we can then ask such questions as: How did the average fund do? How many active funds beat the benchmark index? How many of them underperformed?

The answer? Most active funds – and in some cases a very decisive majority – typically underperform.

Year on year this has been the case. And the latest SPIVA Australia report is no different.

Most Australian active funds underperform the index over the long term

SPIVA has just published its report for the period to 30 June 2018 – showing the relative performance of actively managed investment funds against their respective benchmark indices.

Looking at the results for the year to 30 June 2018, the proportion of active funds in the different asset classes that underperformed their benchmarks is troubling:

  • 58% of Australian equity managers
  • 91% of Australian listed property managers, and
  • More than 70% of international equity managers.

The longer-term performance is even worse.

For the 15 years to 30 June 2018, more than 80% of Australian equity and property funds and 90% of international equity funds underperformed their respective benchmarks.

The table below shows the percentage of funds for the main asset class categories over the 1-, 5- and 15-year periods where active investment funds have underperformed the relevant index.

In other words, while these active managers propose that they will beat the market index – what has happened is that the index has beaten them.

Asset class

 % investment funds that underperformed their benchmark




Aust shares




Aust mid & small cap shares




International shares




Aust bonds




Australian REITs




Source: S&P Dow Jones Indices LLC, Morningstar. Data as of 30 June 2018.

Perhaps we can just pick the winners…

Faced with this evidence, some investors say: that’s okay, I’ll just pick the winners – the small percentage of investment funds who can beat the index. But which funds are they?

This is the trick of course. Because, first the “winners” in any given period are rarely the same. An investment fund that is on top in one year is often in the bottom of the barrel the next.

And second, it is virtually impossible to predict who the winners will be ahead of time. We can only know the winners at the end of the period over which the performance is measured.

Why do the majority of active managers underperform?

Here are three key reasons for active manager underperformance:

1. Active investment managers are getting smarter and better over time as more competition enters the market and technology progresses.

Known as “the paradox of skill”, this means that as more sophisticated investors enter the marketplace, the ability of any one of them to outperform the market will continue to shrink over time. While the absolute skill level of active managers is gaining, with heightened competition, the relative skill level is shrinking.

And, in investing – unlike many forms of competition – it is relative skill rather than absolute that plays the more important role in determining outcomes. As a result, luck becomes a much bigger factor in separating the winners from the losers.

2. Relatively high fees and charges erode active manager returns. 

While a 1% investment management fee may seem like a small number, it is more substantial than many investors realise. In a delightful quote from veteran investor, Charles Ellis he says fees as a percentage of assets are usually described as a four-letter word and a single number. “The four-letter word is ‘only’ and the single number is around 1%”. However, Ellis argues this hides the true picture on fees:

“What is the fee in dollars? Well, it depends on what the returns will be. What’s the expected return from here forward? Many people would feel that the consensus [for equities] was around 7% returns. The same 1% of assets as a percentage of seven [of returns] is 15%. And if you’ve said 15%, you’ve dropped the word ‘only’ because 15% is pretty substantial”.

The alternative, says Ellis, is to choose low cost investment funds that seek to achieve the market return – like an index fund. In this case, in Australia we could have a fee that is around 20 basis points (or 0.20%).

So why would an investor choose an active manager and pay 1%? Because they hope to receive the extra return that the investment manager is promising to achieve over and above the market.

And the fee for that incremental return? That’s our estimate of 1% for an active fund less 0.20% for an index fund – giving an incremental fee of 0.8% (80 basis points). The problem is, as we’ve already discussed, most active managers are not even beating the market – let alone achieving incremental returns as high as 80 basis points.

So, investors who choose active funds are often paying high management fees (plus trading costs) and suffering below market returns.

3. The distribution of returns in the stock market is bizarrely lopsided.

What this means is that in share markets, it is just a few winners that create a positive skew – so, while the overall market index has risen, what’s hidden is that most share prices have fallen. The market increase is thanks to a handful of stocks which have enjoyed gigantic gains.

Here’s what the data from the US share market looks like for the 90-year period from 1926 to 2016:

  • The average annual return of the overall share market was around 7%.
  • Yet, of the 26,000 stocks listed in the US during that time, 86 stocks (or 0.3 per cent) generated more than 50 per cent of the total return.
  • The next top 1,000 (4 per cent) generated all the excess returns over cash.
  • And the other 96 per cent matching cash. Yes, cash!

This interesting feature of share markets was discovered by several academics who identified that the drag from investment manager fees and costs wasn’t enough to explain the degree of consistent underperformance by investment funds compared to their benchmarks.

In fact, these academics argue that even if there weren’t fees and expenses, the odds are that the active fund managers would underperform the market.

Why? Because amongst active investment managers it is popular to create high conviction funds where the manager only focuses on their top picks.

While this sounds good, the problem is that they end up holding only a subset of the available stocks in the market.

Chances are, most investment managers will miss out on owning the biggies. And that, of course, means that they are likely to underperform the share market index.


To be successful as an investor, the evidence is clear: it simply doesn’t make sense to invest your money in active investment managers’ (or your own) high conviction share portfolios or managed funds.

You are better off investing your money with investment managers who offer low cost funds and don’t try to beat the market – but who instead seek to deliver the very best returns that the market has to offer.

Sources: AFR “Why highly paid fund managers struggle to beat the index” April 2017; AFR “Most share market gains come from a very small subset of stocks” June 2017; Robin Powell, The Evidence Based Investor “Charley Ellis: Why active managers extract value from the investment process”, April 2015; Larry Swedroe, “Investors Defy Evidence” July 2018.