Unloved Bull Markets

Chapter 11Active-Passive

Throughout the multiyear bull market it was well documented that mutual funds, on average, did not beat indexes. Promoters of index (passive) investing have spread word of this situation with full force. Significant assets have moved from actively managed funds to passive funds. To understand why assets were moving away from actively managed funds let's analyze the market setting and behavioral finance research regarding active managers. Initially, if we classify stocks by market capitalization and by value-growth characteristics, it can be seen that the first five to ten years of the eleven-year bull market were difficult for active managers due to a setting out of their control.

Market Capitalization

Within the S&P 1500 Index, the S&P 500 Index is composed of the largest 500 companies and the S&P Small-Cap 600 is composed of the smallest 600. Figure 11.1 shows the ratio of the P/E of the S&P Small-Cap 600 divided by the P/E of the S&P 500 monthly from January 1995 through February 2020.

Figure 11.1 Ratio of P/E of Small-Cap 600 to Large-Cap 500

Back to 1995, on average, the P/E on the Small-Cap 600 is greater than the P/E on the (Large-Cap) 500, which makes sense because small companies are growing faster, and investors usually pay a premium for growth potential. The average ratio of the two indexes is 1.25 (top line), meaning, on average, small ...