Active share investors failed to take advantage of last year's volatility

Active fund managers use their skill and experience to pick which stocks to invest in. An alternative to active investing is to invest in low-cost index funds. One criticism of index funds is that they blindly invest in a broad index which might not always make sense. Index funds participate in the highs and lows. This led me to consider how well actively managed funds did last year.Last year’s share market opportunitiesBetween 1 January 2020 and mid-March, the international share index (MSCI World ex-Australia hedged to AUD) fell by approximately 20%. By the end of the 2020 calendar year, the international share index bounced back by around 40% (between mid-March and Dec 2020) to finish the full calendar year up by around 11%.The Australian market didn’t fare as well, but its volatility was still high. The Australian share index (ASX300) fell by approximately 27% to mid-March and then bounced back by almost 33% between mid-March and the end of 2020 calendar year. It finished the 2020 calendar year in a minor loss position (down about 3%).But this is only part of the story. The market’s reaction to Covid created some obvious long term investing opportunities for active investors as some sectors were punished a lot more than others. These include oil and gas, airlines, travel and tourism, real estate and banking.Active fund managers and investors should outperform in a bear marketIn a bull market, almost all stocks are rising so investing in a broad index should capture most of these returns. Logic would have us believe that a bear market probably creates opportunities for active investors. For example, at the heights of covid lockdowns last year, technology stocks were the best performers. But as the vaccines immerged, the sectors that were more severely punished began to recover strongly. As such, and admittedly, with the benefit of hindsight, an active manager could have been overweight tech for half of 2020 and then switched to the recovering sectors for the remaining half of the year. This approach would have outperformed the index.Certainly, we are all wiser in hindsight, and perhaps it’s a little bit unfair to undertake this analysis. However, the point I am attempting to make is that if you pay an active manager higher fees, isn’t it reasonable to expect that they will outperform in such a volatile market?How did active managers do last year?US based index firm, S&P Dow Jones Indices prepares the Standard Poor's Index Versus Active (SPIVA) report every 6 months. It compares the investment performance generated by all active managers to the index, to calculate the proportion of active managers that failed to beat their relevant index. The table below summaries the results for the 2020 calendar year.CountryProportion of active managers that failed to beat the index in 2020USA60%Australia56%Japan54%Europe37%Source: SPIVA reportApart from Europe, more than half of active fund managers failed to beat the index in a year that presented a lot of opportunity to do so.Longer term performance however is more compelling. Generally, over any 5 year period, approximately 75% to 80% of active fund managers fail to beat the index. And of the 20% to 25% of active managers that do beat the index, it’s not the same managers each year. In fact, My new book is available for pre-order now: Pre-ordering the book will help me get it into bookstores. So please do me a favour - please consider pre-ordering now - links and pre-order bonus are available here: https://prosolution.com.au/book-preorder-bonus Do you have a question for the podcast? Email us at [email protected]. If you're interested in working with our team and me, discover how we can work together here: https://prosolution.com.au/family-office-servicesIf this episode resonated with you, please leave a rating on your favourite podcast platform. Subscribe to my weekly blog: https://prosolution.com.au/stay-connected IMPORTANT: This podcast provides general information about finance, taxes, and credit. This means that the content does not consider your specific objectives, financial situation, or needs. It is crucial for you to assess whether the information is suitable for your circumstances before taking any actions based on it. If you find yourself uncertain about the relevance or your specific needs, it is advisable to seek advice from a licensed and trustworthy professional.