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John McMillen | Portfolio Manager

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Have Active Managers "Limited the Downside" in This Market Environment?

June 2009

If there was ever a time in which active managers had the ability to prove their worth, it has been in the past year. After all, if active managers can’t foresee the worst recession and subsequent bear market since the Great Depression, what makes us believe they can see the little ones? With this in mind I recently set out to measure how active managers as a group have fared over the past year.

Using Morningstar’s database, I created a list of actively managed funds benchmarked to the S&P 500 and compared their performance to that index. For reference, I also included data for a fund every investor, big or small, has access to: the Vanguard S&P 500 fund (VFINX). The final list contained 633 actively managed, distinct funds. 

Rather than just looking at how the funds performed over longer time periods, I wanted to examine a key premise of active management – the claim that a good manager will minimize the downside and maximize the upside for you. To do this, I used a measure known as the “Downside Capture Ratio,” which is a measure of how much of the index’s return a given fund was able to capture. (Keep in mind that in a down market, you actually want to capture less of the index’s return).

As you will see in the table below, the average actively managed fund actually lost more than the S&P 500 index, capturing 100.56% of the benchmark’s loss. 

Name

Ticker

Morningstar Category

Downside Capture Ratio 1 Yr

Vanguard 500 Index Investor

VFINX

US OE Large Blend

99.98

Summary Statistics

 

 

 

Ninetieth Percentile

 

 

82.78

Eightieth Percentile

 

 

89.38

Seventieth Percentile

 

 

94.81

Sixtieth Percentile

 

 

97.64

Fiftieth Percentile

 

 

99.92

Fortieth Percentile

 

 

102.39

Thirtieth Percentile

 

 

105.75

Twentieth Percentile

 

 

111.04

Tenth Percentile

 

 

117.66

Average

 

 

100.56

Count

633

 

 

 

Though around 50% of the funds lost less than the S&P, for all except those in the top deciles, the difference was negligible: Keep in mind that even the top-decile funds still lost 28.37% on average.

So what about that top 10% of outperformers? Historically, how have they performed on the upside? Below is another summary table showing how that select group of funds fared in the past on the upside: 

 

Annual Ret 
2008

Downside
Capture Ratio 1 Yr

Upside 
Capture Ratio 1 Yr

Downside 
Capture Ratio 10 Yr

Upside 
Capture Ratio 10 Yr

Average

-28.37

73.40

76.39

85.76

87.23

 

Though the average fund in this select group lost less than the market in 2008, historically as a group, they have not shown the ability to subsequently capture a meaningful portion of the market’s upside.  Comparing the longer term Downside to Upside Ratio shows there is very little added value. 

Perhaps most interesting, these comparisons show that the active managers that protected investors in this down market are not necessarily making brilliant investment decisions, but rather they have simply embraced lower risk strategies.

Though investors may be cheering their performance in bear markets, it is highly probable most are going to experience disappointing relative performance in subsequent bull markets.

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