S&P Active vs. Passive Study Focuses on Sector Funds
By IndexFunds.com Staff

Standard & Poor's released a study showing active sector fund managers have fared relatively well against sector indexes that track thin slices of the market over the past five years. However, over the last three years a majority of active funds beat the indexes in only two out of eight sectors.

In other words, different time periods yielded different results. Judging by the S&P study results, active funds as a group have been largely successful in beating sector indexes over the longer five-year period, but the results have been worse during the bear market of the past three years.

Source: Standard & Poor's. For periods ending March 31, 2003. Outperformance is based upon equal-weighted fund counts.

Among Materials sector funds, 68% and 85% beat the S&P 500 Materials index over last five and three years, respectively. However, while gold and precious metals have performed well over the past three years, the index is poorly represented in this sector.

The benchmarks did well in the sectors traditionally considered as income producing. Over the last five years, 53% of Real Estate sector funds underperformed the S&P REIT Index, and 62% of Utilities sector funds fell short of the S&P 500 Utilities index.

The number of sector funds investors can choose from has risen dramatically in recent years, including several new index-lined sector ETFs and nearly 400 active sector funds, according to S&P.

Many narrow technology funds were launched during the bull market of the late 1990s, and according to S&P nearly a third of all sector funds in the study were classified in its information technology sector. In this sector, 21% of funds liquidated or merged in the last 12 months. In the three years since the technology bubble burst, 66% of funds in this sector fared worse than the S&P 500 Information Technology index, said S&P.

Few equity active vs. passive studies have concentrated on sector investing, with most of the research thus far focusing on broad equity or style categories. This may be due to the difficulty of classifying sector funds, and of finding appropriate benchmarks because active sector funds even within an industry may pursue very different strategies.

S&P noted several issues that complicate benchmark choices for index vs. active performance in sector investing:

1. Index providers have different sector classification schemes, and active managers might not restrict their investments based on any particular sector classification system.
2. While an active sector fund might invest in large-, mid-, and small-cap stocks, there are no broad market sector indices available for popular broad market benchmarks such as the Wilshire 5000, Russell 3000 or S&P SuperComposite 1500. The study used S&P 500 sector indexes; the S&P REIT index was used for real estate sector funds.
3. Sector funds might have small portions of their assets invested outside the U.S.

There are a few sectors in which the number of funds with five-year histories was so small that any index vs. active comparison would be meaningless. After eliminating those sectors, S&P was left with eight sectors for the study: Energy, Financials, Healthcare, Information Technology, Materials, Telecommunications, Utilities, and Real Estate. Funds were classified based on holdings and the fund's investment objective as stated in the prospectus.

The complete study is available on the Standard & Poor's website.

05/14/2003