Few things in life are certain: Death, taxes and active manager underperformance. So no surprise when the latest edition of S&P’s SPIVA scorecard showed most active managers lagged their indexes in FY 2021.

Fifty-nine per cent of active managers in Australian and international equities underperformed their index on a risk adjusted basis in FY 2021, according to the report published Monday. That falls to half for mid-and-small-cap managers. Aussie bond managers were a bright spot, with two thirds beating their index.

The S&P SPIVA Australia scorecard compares the performance of 1,545 Australian funds against their benchmarks. It's part of a series of reports going back to 2002 in the US. 

The report chronicles years of underperformance. In the five years since 2016, roughly 80% of Aussie equity and international equity managers underperformed their indexes. Two thirds of bond managers lagged their index.

Over the ten years since 2011, only 7% of international equity managers beat the index.

Add to this research from S&P showing that most active managers can’t consistently repeat outperformance, and one is led to ask why their clients remain invested.

Part of the reason is fees, says Morningstar manager research analyst Ed Huynh. Underperformance is not just an inability to pick stocks, but also the fees active managers charge. While retail investors must pay up, institutional clients can use their size to lower fees and capture more of the return.

“Big institutional clients like AustralianSuper can get access to active managers for much lower fees than retail investors would pay,” he says.

For example, bronze-rated Platinum International Fund trailed the index by 3.99% in 2020. A third of that was the 1.35% management fee. Gold-rated Magellan Global Open Class trailed the index by 1.04% in 2017, in part thanks to the 1.35% management fee.

Of the five categories covered by the report, international equity managers have the worst average performance versus their indexes.

Since 2011, the S&P Developed Ex-Australia LargeMidCap index returned 15.31% annualised, versus 13.26% for international equity managers. From $10,000 invested in 2011, that’s the difference between $42,000 and $35,000 today.

The data suggests many active managers struggle to capitalise on downturns. On a three-year basis, which includes the covid crash, about three-quarters of Australian and international equity underperformed.

Aussie mid-small cap managers are an exception

The banner for active management is left to Australian mid-and-small-cap managers.

Half of mid-and-small-cap managers beat their index in FY 2021. The ratio is relatively consistent over time, with 47% outperforming over 3-years, 43% over 10 years and 48% over 15 years.

If investors pick the right manager, the difference in returns is significant. Where the S&P/ASX Mid-Small index returned 9% over the last ten years, the average fund pulled in 11% on an asset-weighted basis.

The difference is due to Australia’s smaller size, says Morningstar manager research analyst Chris Tate. Less companies mean the index is smaller and less diversified.

“You’ve got a narrower market where there is a lot of junk in the domestic index,” he says, “It’s easier to outperform.”

Tate says this is less the case when it comes to international small caps because the coverage universe is far larger.

There are 195 companies in the S&P/ASX Small Ordinaries. The S&P Global SmallCap has 9231.

In the Australian small cap space, Morningstar likes the gold-rated Hyperion Small Growth Companies fund.

In the year to 31 August, the fund returned 38.86%, beating its index by 9.78%. Over a 5-year period it returned 17.31%, beating the index by 5.87%.

The top four holdings were Dominos Pizza (ASX: DMP), Xero (ASX: XRO), WiseTech Global (ASX: WTC) and Fisher & Payker Healthcare (ASX: FPH) as of 31 August.