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Why 100% of Passive Fund Managers Underperform Benchmarks*

Updated: Feb 9, 2023

In late 2016, the Financial Times reported that 99% actively-managed US funds were underperforming. In 2017, Fortune titled their piece, 'Stock-Picking Fund Managers Are Even Worse Than We Thought At Beating the Market'. And even up into 2018, articles slamming active fund managers were still being published everywhere from CNBC to Bloomberg.

Hedge fund managers are supposedly one of the shrewdest, smartest people around with yearly salaries of $104,118. So what exactly is up with this reflection of gross incompetency?

Let’s slow down to take a look at some background.

When we discuss passive funds, we are talking about Exchange-Traded Funds (ETFs). ETFs had been around for well over a decade, but they were not bursting in popularity until Warren Buffett came along. He bet that the S & P 500 would outperform a collection of well-established hedge funds over 10 years, and he would go on to win that bet in quite a spectacular manner.

Investors, retail and institutional alike, began digging into the truth of the words uttered by arguably one of the most successful investors of our time.

By 2012, the initial results were in – and Buffett’s opponent was trailing. Badly. This was unusual because funds are known for their outperformance of the market during bear runs, but despite an initial setback for Buffett in 2008, his then position was so favourable that it looked almost impossible to beat. Financial magazines started digging again which led them to feature SPIVA tremendously during 2016.


SPIVA stands for the S&P Indices Vs. Active. It is a biannual report tracking the Active Management versus the Passive Management scorecards i.e. how actively managed funds fare against passively managed ones. Actively managed funds (mutual funds) are positioned against the benchmarks (indices) they are set against in order to determine their success.

SPIVA - underperforming benchmark
SPIVA - fund underperformance / Image Credit: SPIVA

According to the damning articles in the introduction, US fund management performance today is abysmal by paying standards. With further reference to the SPIVA reports on US Domestic Equity performance and setting aside a decent Multi-Cap and Large Cap (Value) performance…

  1. Net of All Fees: US mutual funds in all categories underperformed their benchmarks between 81% to a staggering 98% of the time over the last decade.

  2. Gross of all fees: Even excluding fees involved in mutual funds investment, the underperformance still ranged from as high as 66% to 89% for MidCap400.

The argument for passive funds seems pretty set by this point, but the primary issue that I have with SPIVA is quite simple: it isn't fair. This sounds childish, but it isn’t.

SPIVA does an amazing job of accounting for fees on the active side. The reports are so thorough that they can tell you mutual fund underperformance i) net of fees, ii) gross of fees, iii) in what specific sector and iv) retail or institutional differences. It’s incredibly useful when making a detailed argument for/against passive funds.

However, SPIVA does not tell you about:

  1. The average range of underperformance per mutual fund per sector (easily doable given their resources),

  2. The institutional or retail fees in indices (Indices don’t have fees, despite supposedly representing passive investing).

In order to have a fair comparison, mutual funds should be compared to their ETFs trailing the same benchmark, rather than compared to the benchmark directly.

How can you compare the results of an active investment to that of a passive investment, when the index's lack of investing factors, including fees, already puts it at a bias to come out superior?

Remember, the average ETF has an expense ratio of 0.44% while the average index fund has an expense ratio of 0.74%. Specifics are important, especially when doing comparisons. From the beginning, this has not been an apples to apples comparison.

Let me demonstrate this to you with a personal anecdote:

In April earlier this year, I was tracking the Manulife India Equity Fund. The first four months of the year were brutal despite a strong 2017 performance, and here are the annualised results.

Gross of Fees [management, wrapper]: 10.67%

Benchmark: 8.95%

MF Net of all fees: 8.91%

This was the first time that the annualised return trailed the benchmark. Additionally, if the fund had been reported in SPIVA, it would have been filed under Net Underperformance. Assuming past performance equates to future performance (which is but a rule of thumb), then passive would win hands-down. Or would it?

Benchmark: 8.95%

ETF net of fees: 8.55%

Consider this argument:

The active versus passive debate is not uncommon. Domestic US fund performance speaks for itself – investors utilising actively managed funds in efficient markets, lest bonds or Accredited Investor equity hedge funds – will be subject to high chances of underperformance.

As a Financial Planner who specialises in fixed income and inefficient markets – where actively managed funds outperform passively managed funds by large margins - I am confident that I can turn an active fund investment into gains for you.

If you need convincing about my investing competency then let me share with you how I managed to achieve a 49.6% net of fees yield in inefficient markets like China and India last year as well as a 32.7% yield in my overall portfolio. The numbers speak for themselves.

As we continue to search for the best value-for-money deals and investments, we always have to consider the specifics. If you enjoyed the article or have some thoughts or comments on how you can start developing your streams of income, do like - comment and subscribe!

Money Maverick


If you look at the SPDR STI ETF, my statement doesn’t hold any water. The STI ETF is outperforming the STI index by almost 3 percentage points. This is not all that uncommon – a phenomena occurs like this in unit trusts as well, despite it’s alleged outperformance since inception.

From above, you can see that the 10-year annualised performance of the fund trailed the benchmark but has outperformed the benchmark since it’s inception. This was made clear in my rebuttal to a recent Dr Wealth article.

Here are some factors that cause this disparity:

1) Entry Bias: The primary reason for the above error – the creation of the fund at a particular entry point creates a false impression of its actual performance over time.

If the index is experiencing high volatility across a couple of years and the fund is created during a particularly good year, the fund performance will be skewed showing a 'a better' performance than the index.

2) ‘Weighted’ Error: More common in hedge funds but increasingly so in ETFs as managers tracking the index attempt to beat the market index with minimal costs.

3) Tracking Error: Failure to track an index perfectly may lead to larger disparities in underperformance of the index, but it may also lead to accidental outperformance.

Source 1: “The average ETF carries an expense ratio of 0.44%, which means the fund will cost you $4.40 in annual fees for every $1,000 you invest. The average traditional index fund costs 0.74%, according to Morningstar Investment Research.”

Co-written by Samantha Tay.

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