Active managers versus the bear

A frequently trotted out justificationfor paying expensive fees for activelymanaged funds is that active managerscome to the fore during bear markets.It's too much (it seems) to expect them tokeep up with indices during stockmarketrallies and volatile market periods. Butwhen a downturn comes, while passivefunds plunge with the underlying market,active managers can offer some security,upping their cash reserves and movinginto more defensive positions. That'swhen you'll be thankful you handedall that money to your beaming fundmanager, as your passive-investor friendstear their hair out. Or so the story goes.

But as with many tales told to justifypaying active fees, it's simply not true, asnew research from Morningstar, based onperformance during the recent downturn,reminds us. John Rekenthaler comparedthe returns of US actively managed funds(large-, mid- and small-cap) from May2015 to 15 January 2016 to that of therelevant Russell (US stockmarket) index.For each size of fund, he looked at threecategories: growth, value and "blend" (ahybrid of the two).

When looking at large- and mid-capfunds, active funds lagged the index inall three categories. Among large-caps,growth funds fared the worst, withonly 23% outperforming the Russell1000 Growth index. For mid-caps,roughly a third of active funds beat theindices. Small-cap funds showed themost promise (by which we mean theywere "the least worst"). Active funds inall three categories beat the index morethan half the time (ranging from 53% to61%). "It wasn't a resounding success by any means, but small-company fundsoffered at least a hint of an umbrella,"says Rekenthaler.

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Rekenthaler himself admits that "thishasn't been a full test of active funds'downside protection" even the worstof the nine Russell categories (small-capgrowth stocks) haven't quite fallenby the 20% that constitutes a bearmarket (yet). But this research onlyconfirms a swathe of past data. "Thebelief that bear markets favour activemanagement is a myth," argues credit ratingsgroup Standard & Poor's.

Overthe five years from 2004 to 2008, 72%of actively managed large-cap fundsunderperformed the S&P 500; theresults were similar from 1999 to 2003(both periods included significant bearmarkets). "In the longest downturns,defined as declines of five consecutivemonths or longer, index fundsoutperformed actively managed funds100% of the time," reports financialadviser Vista Capital, quoting researchby Schwab, which analysed marketdeclines between December 1986 andMarch 2001.

It's no secret that at MoneyWeek we tendto favour passive investing. You can'tpredict when a bear market will strike(if you could, you'd move to 100% cash,rather than try to find the active managerwho'd lose you the least money), but youcan control how much you waste on feeswhen you invest. But if you're looking fordecent bear-market funds, there are a fewthat have proved their mettle.

As NatalieStanton noteda few weeksago, any of Ruffer Total Return, TroyTrojan or Personal Assets Trust (which isin our model investment trust portfolio)would make good conservative additionsto a portfolio.