List the conditions an active fund would have to meet before you would consider it.
When you look at the evidence on active funds, it is easy to read it in support of whatever you already believed. The research is mixed enough to back almost any view, and most people take from it the view they started with. The remedy is to decide what an active fund has to show before you see how any particular fund has done. Nothing here argues for buying active funds or for avoiding them. The aim is a fair test, built from four conditions, so that if you do pay an active fee, you can say what it is paying for.
Two investors show the difficulty. Arjun read a SPIVA scorecard and was prepared to give up on active funds altogether. Wei Ling was not prepared to do that: the manager of her fund had a long record, its factsheet showed some good years, and her relationship manager spoke about it with confidence. Each of them was responding to evidence, and neither had settled in advance what the evidence would need to say.
Your first condition is to compare like with like. Put the active fund next to an index fund from its own category, one holding the same kind of assets in the same markets. For an Asia ex-Japan equity fund, the yardstick is an Asia ex-Japan index fund. A world equity fund, a US fund or a bond fund would each give a misleading result.
Sales conversations often mix categories. A typical line is that an Asia fund has beaten the STI over five years. Since the fund owns different shares in different markets from those in the STI, the claim says very little. The fair question is whether the fund beat the cheapest sensible way to own the market it actually invests in.
Your starting point is the benchmark printed on the factsheet, as Lesson 1.3, "Find the facts in a fund's three key documents", explained. Before relying on it, confirm that it matches the fund's real holdings. Lesson 6.4 walks through that check in detail.
The second condition covers the numbers themselves. Use returns after every fee has come out, sales charge included, and measure them over a full market cycle, meaning a stretch long enough to take in a strong rise and a real fall. A rough guide is at least five to ten years, and longer if the data allows.
A single strong year carries little weight, because across short periods luck can completely swamp skill. Some active approaches do very well while markets climb and badly when they drop, and some do the reverse. If a fund beat its index by a wide margin last year, it may only have owned more of whatever went up. A full cycle at least lets you see how the fund coped in different conditions.
Whenever you're shown a performance chart, look at the date it begins. A chart that opens at a market low flatters almost any fund, so treat a five-year chart drawn from a low with caution.
The third condition is a second, independent source. SPIVA is one source, and it's a sound habit to see whether another one, built on a different method, gives the same answer for your category.
Morningstar, a fund research firm, publishes the Active/Passive Barometer. Instead of setting active funds against an index, it sets them against passive funds in the same category. The distinction matters because an index carries no costs while a real index fund does, so the Barometer measures active funds against something you could actually buy. As SPIVA does, it includes funds that were closed or merged, and it gives results over several periods.
When the two sources agree for the category you're looking at, you can hold your view with more confidence. When they disagree, find out the reason. It usually lies in how each one measures, and the gap between them can itself tell you something.
The fourth condition is the one people find hardest to accept: past results do not predict future ones. A fund's earlier outperformance, taken alone, is weak evidence that it will outperform from here. The SPIVA persistence scorecards check whether top-performing funds stayed at the top, and their findings show how much weight a strong track record can carry. Lesson 6.2, "What the SPIVA reports measure and show", goes through these scorecards.
Go beyond whether the fund has done well and look for a reason it should continue to. Four points are worth checking:
whether the same manager has been in charge throughout whether the approach is clear and steady or shifts with fashion whether the fund is still small enough to follow its approach, or has grown so big that it now looks like the index at an active price whether the cost gap over an index fund is narrow enough for modest outperformance to cover it
None of these guarantees anything. Each one is a reason to think a record might reflect more than luck.
No single set of conditions is the right one. What counts is the timing: write yours down before you see any particular fund's results, so those results have no say in the test.
Wei Ling's came to three sentences. Her fund has to beat a same-category index fund after all fees, over at least ten years. It has to have kept the same lead manager for most of that period. Its yearly cost can be no more than one percentage point above the index fund's. Arjun later wrote conditions that were stricter than hers.
In the activity below you will write three conditions of your own.
Write down three conditions an active fund would have to meet before you would pay its fee over an index fund's.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).