“NOW SHOW JAPAN” is commonly shouted (over the internet) by people looking to debunk an investment strategy. Japan is notorious for being the exception to the rule, where more common investing strategies would have struggled or failed, thanks to the country’s unique economic history – including the famous real estate bubble in the 1980s from which the market is still recovering. However, Japan’s stubbornness in refuting investing strategies does not hold for the active vs passive debate. Japan has similar, albeit less extreme, results than in other regions – passive funds are still outperforming their active counterparts in Japan.
- Across all data sources, over 50% of active Japanese equity funds underperformed their benchmarks over the last 10 years, both on an absolute and risk-adjusted basis.
- This is also true for Japanese small- and mid-cap equities – thought to be some of the least efficient markets, where active managers should thrive.
Section 1 of this post focuses on 2 sources of data: the Morningstar Active/Passive Barometer and the SPIVA reports. Both reports are updated every 6 months, and are cited widely in the industry as being the “scorecard” for assessing the performance of active funds. Both studies are conducted independently using their own separate data sets.
Section 2 contains a selection of other recent relevant studies that also contribute to the active/passive performance debate. Despite not being updated as regularly as the Morningstar and SPIVA reports, their conclusions are equally worth reading.
The Morningstar Active/Passive Barometer and the SPIVA reports
This section summarises the performance of active funds in Japan over the last 10 years, relative to their passive benchmarks. There is considerably more data in the underlying reports, which can be found here, here, and here.
- Over the last 10 years, across both datasets, the majority (over 50%) of Japanese active equity funds underperformed their benchmark. SPIVA data shows between 57% and 60% of funds underperforming, whilst Morningstar data shows between 65% and 82%.
- S&P Dow Jones also provide data for the risk-adjusted return characteristics of the active funds vs their benchmarks. Results here are similar for pure outperformance, with 57% – 64% of active funds underperforming their benchmarks on a risk-adjusted basis.
- Looking at survivorship, SPIVA data shows 59%-65% of equity funds surviving after 10 years – higher than in other regions. Given the overall outperformance of passive funds, these surviving funds must have underperformed their benchmarks in aggregate.
- According to Morningstar, 35% of Japanese active equity funds survived after 10 years.
NB: S&P Dow Jones compares active funds’ performances against their S&P-assigned costless benchmark, based on the funds’ Lipper classifications. Morningstar compares active funds’ performances against a composite of actual passive funds – their “benchmark” reflects the actual, net-of-fees performance of passive funds.
NB: Standard deviation of monthly returns, over a given period, is used to define and measure risk. The return/risk ratio is used to evaluate managers’ risk-adjusted performance. Returns of the benchmarks are also adjusted by their volatility.
NB: Survivorship is calculated by dividing the number of distinct funds that started and ended the period in question by the total number of funds that existed at the onset of the period in question (the beginning of the trailing one-, three-, five- and 10-year period)
Further evidence from other sources
Vanguard’s research paper, ‘The case for low cost index-fund investing’ shows on page 9 how between 60% and 90% of active funds underperformed their benchmarks over the last 15 years across all measured regions:
Lyxor’s research paper, ‘Analysing active & passive performance: What 2017 results tell us about portfolio construction’ shows on page 9 that between 11% and 50% of active equity funds outperformed their benchmark over the last 10 years – with 23% of active Japanese equity funds outperforming: