The Volatility of Active Management


S&P Dow Jones Indices has long provided a great service to investors with its semi-annual S&P Indices Versus Active (SPIVA) scorecards. The evidence offered in these reports has shown time and again that, regardless of the asset class, the vast majority of active managers persistently fail to outperform their benchmarks, and that there is little to no persistence of performance beyond the randomly expected.

Thus, while we know that there will almost certainly be some small percentage of active mutual fund managers who will outperform in the future, being unable to use past performance as a predictive metric means there is no reliable way to identify them ahead of time.

S&P Dow Jones Indices recently produced a new study that looks not just at the returns of actively managed funds, but also at their volatility (one measure of risk). One purpose of the study was to test whether past volatility was predictive of future volatility. The following is a summary of the author’s findings:

  • Typically, active funds offered higher volatility than their category benchmarks, although not always and not in every mutual fund category. An average of 80 percent of U.S. funds and 65 percent of European funds demonstrated greater volatility than their category benchmarks.
  • While there is no persistence of performance beyond the randomly expected, there is persistence in relative fund volatility, particularly for the most and least volatile funds. About two-thirds of funds in the most volatile quintile in a two-year period remained in that quintile over the next two-year period, and about two-thirds of the least volatile funds in a two-year period remained in the two least volatile quintiles over the next two-year period.
  • The performance of high-volatility mutual funds appears to stem from a bias toward higher-beta stocks.
  • The performance of low-volatility mutual funds tends to be driven by large cash allocations (as opposed to a bias toward low-beta stocks). Specifically, researchers concluded that the performance of low-volatility funds could be replicated by holding an 11 percent position in cash.
  • Funds in the top quintile of volatility produced slightly lower returns than the S&P 500 Index (7.8 percent versus 7.9 percent) and also exhibited higher volatility (17.2 percent versus 14.7 percent). The average exposure of top-quintile funds to market beta was 1.15 versus 1.00 for the S&P 500 Index.
  • Funds in the lowest quintile of volatility produced lower returns than the S&P 500 Index (7.2 percent versus 7.9 percent) although, as you would expect, they did exhibit a lower volatility (13.2 percent versus 14.7 percent). The average exposure of bottom-quintile funds to market beta was 0.89. However, their correlation of returns with the S&P 500 Index was 0.99. This finding indicates that the lower market beta exposure was the result of holding cash, not of holding low-volatility stocks, whose correlation with the market was about 0.75. As you should also expect, the low-volatility funds underperformed in bull markets and outperformed in bear markets.


The bottom line is that the evidence shows investors were not able to improve their returns relative to the market either by investing in higher-volatility actively managed funds (taking more risk) or by investing in low-volatility actively managed funds. In other words, the study provides further evidence that active management is a loser’s game; while it’s a game that’s possible to win, the odds of doing so (especially for taxable investors) are too low to make playing a prudent decision.

This commentary originally appeared November 2 on

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