You will be able to set out the conditions under which you would consider an active fund.
After reading a SPIVA scorecard, Arjun was ready to write off active funds entirely. Wei Ling was not. Her fund's manager had a long record, the factsheet showed some good years, and her relationship manager was confident. They were both reacting to the evidence, in opposite directions. What neither had was a set of conditions, decided in advance, that an active fund would need to meet.
This lesson builds those conditions. It does not tell you to use or avoid active funds. It sets out how to judge one fairly, so that if you pay an active fee, you know why.
The first condition is about the comparison itself. An active fund should be compared with an index fund in the same category, holding the same kind of assets in the same markets. An Asia ex-Japan equity fund should be measured against an Asia ex-Japan index fund, not against a world equity fund, a US fund or a bond fund.
This sounds obvious, but comparisons across categories are common in sales conversations. "This fund returned more than the STI over five years" says little about an Asia fund, because it holds different shares in different markets. A fair test asks whether this fund did better than the cheapest reasonable way of holding the same market.
The benchmark on the factsheet is the place to start, as lesson 1.3, Find the facts in a fund's three key documents, explained. Check that it matches what the fund actually holds. Lesson 6.4 does this check in detail.
The second condition is about which returns you look at. Look at returns after all fees, including the sales charge if you paid one, and over a full market cycle, a period long enough to include both a strong rise and a real fall. A rough guide is at least five to ten years, preferably more.
One good year proves little. Over a short period, luck can swamp skill entirely, and some active strategies look brilliant in a rising market and poor in a falling one, or the reverse. A fund that beat its index by a wide margin last year may simply have held more of whatever happened to rise. Looking across a full cycle at least tells you how the fund behaved in different conditions.
Watch for the period a chart starts from, too. A five-year chart that starts at a market low will flatter almost any fund.
SPIVA is one source. A good habit is to check whether a second source, measuring things differently, tells the same story.
Morningstar, the fund research firm, publishes the Active/Passive Barometer, which compares active funds with passive funds in the same category, rather than with an index. That difference matters: an index has no costs, but a real index fund does, so the Barometer compares active funds with something you could actually buy. Like SPIVA, it counts funds that closed or merged, and it reports results across several periods.
If both sources point the same way for the category you care about, you can be more confident in the picture. If they differ, read why. The difference is usually in how they measure, and it can tell you something.
The fourth condition is the hardest to accept. A fund's past outperformance, on its own, is weak evidence that it will outperform in future. This is why the persistence scorecards from lesson 6.2, What the SPIVA reports measure and show, matter. They test whether top-performing funds stayed on top, and the answer tells you how much weight a strong track record can bear.
So ask more than "did it do well?" Ask whether there is a reason it should keep doing well. Has the same manager been running it the whole time? Is its approach clear and consistent, or does it change with fashion? Is the fund still small enough to follow its approach, or has it grown so large that it now looks like the index at an active price? Is the cost gap over an index fund small enough that modest outperformance would cover it?
None of these guarantees anything. They are reasons to believe a record might reflect more than luck.
Wei Ling's conditions came out as three sentences. The fund must beat a same-category index fund after all fees, over at least ten years. It must have kept the same lead manager for most of that time. And its yearly cost must be no more than one percentage point above the index fund's. Arjun's were stricter.
There is no single right set. The point is to write yours before looking at any particular fund's results, so the results cannot shape the test. In the activity below you will write three conditions of your own.
Write three conditions an active fund would need to meet before you would pay its fee instead of an index fund's.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).