As we all start practicing #socialdistancing, markets are tumbling faster than ever before. Since the February 19 high, the S&P500 closed on Monday March 2nd down a whopping 34%!  Some investors are naturally thinking of selling their actively managed funds to move into passive funds, but our research shows that’s exactly the wrong thing to do.

Wall Street

Style Analytics investigated the performance of active management compared to passive investments during market downturns.

The conclusion: quality active managers significantly beat the broad market in down months and especially in the worst four market crises over the past twenty-five years.

We looked at over 1,000 actively managed US funds (from the eVestment Large Cap US Equity database) between 1995 and 2020 and found that, on average, they consistently beat the broad Russell 1000 index. In falling markets, the best 25% of managers beat the market 60% of the time while the best 5% of managers beat the market 75% of the time.

Conventional wisdom says that because passive investments have no breaks – they aren’t even aware of risks – that good active management should outperform passive investments during times of market stress. Our analysis shows that good active managers not only beat passive investment during downturns, but that the outperformance grows with larger market losses.

We looked at four crises over the past 25 years: The Tech Bubble from August 2000 through September 2002 (with a 41% loss), the Global Financial Crisis from October 2007 through February 2009 (with a loss of 50%), the Debt Downgrade from April through September 2011 (with a loss of 15%) and the Taper Tantrum from September through December of 2018 (with 13% loss).

Figure 1 shows the frequency with which managers, in increasing ‘quartiles’, outperformed the broad index for both up markets (blue) and down markets (orange). The median manager underperforms the Russell 1000 46% of the time in up markets and outperforms the Russell 1000 51% of the time in down markets, showing that the average manager does indeed provide near-benchmark returns. However, the top 25% of managers, who outperformed the benchmark only 51% of the time in up markets, beat the benchmark 60% of the time in down markets.


Active managers beat the broad market in downturns and crises

Figure 1: Fraction of months during which active managers beat the Russell 1000 index in up (blue) and down (orange) markets. Active manager outperformance is even better during crises (red).

The spread between up and down markets grows when considering the top 5% of managers who beat the benchmark 75% of the time in down markets but outperformed up markets only 60% of the time. In times of large market losses, the best 25% of managers and the best 5% of managers each increased the fraction of time they beat the index. Good managers outperform the passive index in market downturns and outperform even more so during crisis periods.

Downside risk protection is a core benefit of top performing active equity managers.

Focusing on just the crises, we measured the average monthly underperformance / overperformance of the five percentile categories: 5th percentile (lowest performers), 25th, 50th percentile, 75th and 95th percentile (best 5%), during each of the four crises. The results are shown in Figure 2 below. Of the four crises studied, the Tech Bubble had the largest outperformance by managers, likely because its epicenter was an easily identifiable and ‘hedgeable’ industry. Each of the other crises shows a consistent outperformance of over 40bps per month for the top 25th percentile and well over 140 bps per month for the top 5th percentile.

Active manager outperformance increases with size of crisis

Figure 2: Average monthly outperformance of active managers during each of the crises identified in the text

We also organized the overall active manager outperformance of the Russell 1000 into four quartiles, presented in Figure 3, to show that the outperformance of the average active manager increases with severity of downturn. During the most severe downturns, active managers as a group provide market outperformance of almost 30bps per month.

Active manager outperformance increases with size of crisis

Figure 3: Active manager outperformance increases with increasing severity of market crisis.

These results show that active equity portfolio management provides downside protection that increases with worsening market downturns.

As the COVID-19 pandemic causes significant disruption in global markets, the temptation to reallocate from active to passive should be tempered by the realization that active management often provides a level of downside protection not observed in core passive investments.

You can download the full report here.


Leave a Reply