Active versus Passive Management of International Mutual Funds ...

allocations. They did not determine whether active or passive management was better, but that
both had compelling strengths and weaknesses. They felt that active and passive management
should be complementary rather than battling to see which one survives [36].
Batten [11] provided a study of 22 funds using Morningstar Principia Pro data covering
the 1970 to 1999 period. The results indicated that active management could provide some value
through superior risk adjusted returns. The study was limited in scope and did not adequately or
significantly support the argument for active versus passive management of mutual funds.
Davis [28] supported the purchase of the index instead of actively managed funds. He
used the U.S. Mutual Fund Database from the CRSP covering the period 1962 to 1998; the
sample consisted of 4,687 funds. The significance of the study was that all funds during the
period were included, even those that died. The only good news for actively managed funds was
evidence of abnormal performance among some of the best performing growth funds, but this
performance was not sustainable for more than 1 year [28].
Damato [27] supported the growing trend to indexing. She reported the active managers
did well in 1999, as they achieved an average gain of 29.2% versus the S&P 500’s 21% return.
In 2000, the S&P 500 lost 9.1% while the active managers lost only 1.3%. Unfortunately, for the
previous 20-year period, the result was much different. She stated that according to Lipper the
average diversified fund returned an average of 13.23% while the S&P 500 index returned
15.48% [27].
Frino and Gallagher [40] conducted a narrowly focused study of 42 S&P 500 index funds
from the Morningstar Principia Pro CD-ROM, covering a 5-year period ending in February
1999. The study focused on the tracking error of the passive fund compared to the index. They
found statistical evidence that tracking error was positively and significantly correlated with
dividend payments from the securities comprising the S&P 500. Additionally, they observed
that, on average, actively managed funds significantly underperform passive benchmarks.
Furthermore, the S&P 500 index funds earned higher risk adjusted returns than active large
capitalization funds. They felt there was no economic benefit for the average investor to invest in
actively managed funds [40].
Israelsen [51] reiterated previous thoughts that active versus passive management was not
good versus evil, but should be viewed as complementary. He felt both approaches are correct.
The planner, whether selecting active, passive, or a combination of both, should stay the course.
Constant change will lead to a loss of capital for the client [51].
Adrangi, Chatrath, and Shank [1] revisited the EMH as they tested active manager and
passive index portfolios against randomly selected dartboard selections. They utilized the
Treynor [84], Sharpe [75], and Jensen [52] risk-adjusted portfolio performance measures. Their
findings indicated that active managers beat the short term, 6-month performance of the
dartboard portfolios and the market indices. The study findings were limited in scope and
indicated, in the short term, that the market does not reflect all available information [1].
Bogle [17] provided additional support for his findings in Bogle [18] by addressing the
period July 1, 1991 through June 30, 2001. This period included the quiet period of 1992 to
1994, the boom of 1995 to 1999, and the bust of 2000-2001. The results were similar as the small
cap funds outpaced the large and mid cap value funds. The Sharpe ratio of the index funds (1.23)
exceeded the average managed fund (0.99), the high cost funds (0.84), and the low cost funds
(1.13) [17]. The only area where active managers appeared to be better was in the small-cap
growth category that was consistent with the previous study.
Fortin and Michelson [38] provided support for index funds, but also identified categories
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