Proponents of active management say funds that don’t track an index are positioned to outperform when markets are volatile and decline. While it’s true that some active categories set performance records in 2022, there were also pockets of weakness.
Big picture? Equity strategies had stronger hit rates (percent of funds outperforming) and average excess return figures than active bond funds, which posted their weakest results in five years.
But the real question is, what do last year’s active management performance trends mean for portfolio construction decisions in 2023?
In 2022, roughly 63% of all active equity managers beat their benchmark, the best hit rate in 15 years and well above the historical average of 45%.
This also marks the first time in 15 years when more than half of the active equity universe had positive alpha in back-to-back years, since 59% of active equity funds beat their benchmark in 2021.
Where exactly did active management shine in 2022?
2022 also marks the second consecutive year that more than 60% of value and blend managers beat their benchmark, a feat not seen in 15 years.
But that outperformance didn’t translate to overseas or growth funds. In all non-US and growth categories, fewer than 50% of managers outperformed in 2022. In fact, emerging markets (EM) and all three growth market cap profiles saw double-digit percentage decreases to their long-term average.
For EM this breaks a three-year stretch of more than 50% of managers beating their benchmark. Given the idiosyncratic turmoil within EM, from the Russia-Ukraine war to China’s zero-COVID policy, this isn’t a surprise.
Excess returns for Value and Blend funds were well above their historical averages, as shown below. In fact, both Large Blend and Mid Blend categories posted their highest average excess return in 15 years, 1.49% and 2.40%, respectively.
This strength stems from value’s strength as a factor/style and the long-standing value bias many core blend active managers have. Pure value stocks beat the S&P 500 Index by 16.1% in 2022, the most since 2009.1 At the same time, pure growth stocks underperformed the S&P 500 the most since 2002.2
Small Value had the largest excess return, at 5.33%. The remaining two value disciplines rounded out the top three, upending the Purity Theory’s premise, which states that the style in favor (in this case, active value) usually leads to stronger performance for the opposite of that style (in this case, active growth) due to the style drift of the latter.3 The performance of active growth managers also challenges the Purity Theory.
If the value factor continues to perform well in 2023, strength from that bias and focus could lead to similar strength for blend and pure value managers this year — not to mention any smart beta multi-factor strategies that use value as an input, or even specific single-factor, value-oriented smart beta funds.
While many equity categories had record-setting performance in 2022, active bond funds overall had a lackluster year. Roughly 40% of managers outperformed their prospectus benchmark. This is the lowest rate since 2018 and 11 percentage points below the historical average — typically, more than half of bond managers beat their benchmarks.
Only three categories had better-than-average hit rates and higher-than-usual average excess returns in 2022: EM, high yield, and multi-sector bonds.
The lesser-constrained multi-sector bond funds produced the best results. More than 77% of multi-sector active managers beat their benchmark one year after 96% of managers had, as shown below. The remaining six categories saw below-average performance, with less than 50% of managers beating their benchmark.
Average excess returns were similar to hit rate trends, as only the same above three markets saw positive average excess returns in 2022. And, once again, multi-sector bond funds delivered the strongest results, with an average excess return of 1.95%.4
This breaks a streak of outperformance for Intermediate Core-Plus managers. In five of the last six years, more than 70% had beat their benchmark. The last time less than 70% of Intermediate Core-Plus managers outperformed was in 2018, a year not unlike 2022, when rate and credit volatility were both elevated.
But I don’t believe weakness in those core segments should deter investors in 2023. After all, following 2018, for three straight years more than 70% of Intermediate Core-Plus funds outperformed, with an average excess return of 82 basis points a year.5 Also, strictly confining the core of your portfolio to Agg-based bonds is limiting. It’s also risky, given the prospect for higher rates ahead and how duration effects have been the sole driver of negative returns.
While only 31% of active managers beat the benchmark, 51% did have lower realized volatility than their prospectus benchmark in 20226 — an example of how active duration management, sector allocations, and security selection may be able to better defend against rate and credit volatility than vanilla indexed core Agg bonds.
Active management’s strong 2022 results are likely to spur more interest in active strategies, something we’ve begun to see in the ETF market.
Active ETFs took in $100 billion of inflows last year.7 Yet, some of those were into defined-outcome, option-based strategies that target a more convex payoff and aren’t solely focused on delivering alpha. Nevertheless, we’ll likely see a proliferation of active funds and inflows this year — perhaps even in the mutual fund industry.
That said, equity strategy trends are facing a mixed backdrop that wouldn’t normally create a conducive environment for alpha.
In both US large and small caps cross-sectional stock dispersion is below average, while pairwise correlations are above average.8 This signals a clustered/macro-driven market where there is little difference among stock co-movements, making it challenging for active to outperform consistently.
Because this could upend the recent trend of active equity outperformance, anyone planning to use only active equity strategies in 2023 may want to rethink their approach. After all, the saving grace for alpha in 2022 was market breadth.
In 2022, 56% of US stocks beat the broad index return, a rate above the long-term average of 49%.9 With more stocks beating the index, chances for a correct overweight position to add alpha improve. As a result, breadth will be a very important metric to watch if active stock-picking patterns from 2022 carry over into 2023 — and if there will be a three-peat of more than 50% of equity managers beating their benchmark.
1 Bloomberg Finance L.P. based on the return of the S&P 500 Pure Value Index as of December 31, 2022
2 Bloomberg Finance L.P. based on the return of the S&P 500 Pure Value Index as of December 31, 2022
3 “When Indexing Wins and When It Doesn’t in US Equities: Updating and Extending the Purity Hypothesis”, Thatcher, Institutional Investor Journals, 2017
4 Morningstar as of December 31, 2022 based on SPDR Americas Research Calculations
5 Morningstar as of December 31, 2022 based on SPDR Americas Research Calculations
6 Morningstar as of December 31, 2022 based on SPDR Americas Research Calculations
7 Bloomberg Finance L.P. as of December 31, 2022 based on SPDR Americas Research Calculations
8 "US Mutual Fund Performance Update", BoFA US Equity Strategy January 9, 2023
9 Bloomberg Finance L.P. as of December 31, 2022 based on SPDR Americas Research Calculations of stocks in the S&P 1500 Index
S&P 500 Index
The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities and serves as the foundation for a wide range of investment products. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.
S&P 1500 Index
The Standard & Poor's 1500 Composite is a broad-based capitalization-weighted index of 1500 U.S. companies and is comprised of the S&P 400, S&P 500, and the S&P 600.
S&P 500 Pure Value and Pure Growth Index
The S&P 500 Pure Value and Growth Indexes are a style-concentrated index designed to track the performance of stocks that exhibit the strongest value (or growth) characteristics by using a style-attractiveness-weighting scheme.
The views expressed in this material are the views of the SPDR Research and Strategy team through the period ended January 10, 2023, and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor.
Unless otherwise noted, all data and statistical information were obtained from Bloomberg Finance, L.P. and SSGA as of December 7, 2022. Data in tables have been rounded to whole numbers, except for percentages, which have been rounded to the nearest tenth of a percent.
All information is from SSGA unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
Investing involves risk including the risk of loss of principal.
Equity securities may fluctuate in value and can decline significantly in response to the activities of individual companies and general market and economic conditions.
Because of their narrow focus, sector investing tends to be more volatile than investments that diversify across many sectors and companies.
The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA’s express written consent.