The Active versus Passive debate rages on, but the results would suggest that large capitalization active managers are about to lose on a 10-count! According to a SPIVA study of large-cap managers versus the S&P 500 through December 31, 2017, 89.5% of managers failed to beat the index for the 10-year period. Results are slightly better for the 3- and 5-year periods at 80.6% and 84.2%, respectively, but the slight improvement shouldn’t give anyone too much confidence that the tide is about to change.
However, I believe that the percentage of large-cap U.S. equity managers will begin to outperform. Why? At KCS, we think that there are three environments that favor active managers versus the S&P 500, including markets that favor value, smaller capitalization stocks, and bear market environments. The last 10 years have been dominated by large-capitalization growth stocks, as the Russell Top 200 Growth Index has bested the Russell Mid Cap Value index by 2.3% per annum. The margin of outperformance has continued to grow substantially in recent periods, peaking (?) at 18.6% in 2017 (31.9% versus 13.3%).
So, what gives us reason to believe that value-oriented, smaller capitalization securities will once again have their day in the sun? History! History has a way of repeating itself, and so do market cycles. Mid-cap value ate large growth’s lunch for the 20 years ending 12/31/17 (9.5% versus 6.6%) despite the significant underperformance during the last 10+ years. Also, valuations and fundamentals ultimately matter, and there is little justification for the valuations currently attributed to the top 200 growth stocks.
We believe that there is a role for both active and passive management in a well-diversified equity portfolio, but the large growth versus mid value cycle should be used to “tilt” one’s portfolio within appropriate asset allocation bands. If you aren’t prepared to bet that large growth will continue to significantly outperform mid value then you should act sooner rather than later before the next cycle is well underway.