Comparing Active and Index/Passive Small-Cap Funds

Writing in Adviser Perspectives, Larry Swedroe of the BAM Alliance evaluates the performance of the 10 largest (by assets under management) actively managed small-cap funds over the period 2000-15 in comparison to the performance of small-cap Vanguard index funds and Dimensional Fund Advisors passively managed structured asset class funds, and also uses S&P Indices Versus Active (SPIVA) Scorecard data for a similar comparison over the 2005-15 period. His broader purpose is to investigate the claim that “the market for small-cap stocks is less informationally efficient, thus allowing [active managers] to uncover mispriced securities and generate alpha.” He concludes that “the winning strategy is to choose low cost funds – either pure index funds or well-designed passively managed funds.” The conclusion results, primarily, from his finding that “the vast majority of actively managed small-cap funds underperform – and when they do so, they tend to outperform by much greater amounts than the winners are able to outperform,” as well as fee and tax considerations.

Swedroe notes that his data set – the ten largest actively managed funds – creates several biases, but suggests all of them should tend to be biased toward stronger than average performance. And he does find some outperformance, particularly in comparing the actively managed funds to Vanguard index funds 2000-15: “just one of the 10 largest actively managed small-cap funds underperformed” the index funds with an average outperformance of 1.5%. Compared with the DFA portfolios, “four of the five largest actively managed small-cap funds outperformed” with an average outperformance (where calculable) of 0.7%.

Applying a six-factor analysis for the 2001-15 period, Swedroe finds that “just four of the market’s largest small-cap funds produced positive alphas, and not one of them was statistically significant at the 5% level.” Further, “the average alpha was slightly negative.” He suggests this reflects “how hard it has become to generate alpha once exposure to common factors is incorporated.”

Among other things, Swedroe’s SPIVA scorecard analysis yields the following: “of actively managed small-growth, small-blend and small-value funds, 92%, 89%, and 86%, respectively underperformed their benchmark index.” Swedroe digs into the data behind these numbers in some depth, leading him to the conclusions noted at the outset of this post.