At Invesco, we believe high-conviction portfolios can include actively managed funds, smart beta strategies and traditional passive approaches that are all intentionally chosen and allocated with a client's goals in mind.

Why invest in average? Five truths about benchmark investing

The third publication in our Active/Passive Debate White Paper Series examines five common misperceptions about passive, broad-market, cap-weighted benchmark strategies, and we dig deeper to reveal the five truths that investors need to know when building portfolios.

At Invesco, we believe that a wide variety of strategies can play a role in a well-constructed, high-conviction portfolio, but investors need to base their decisions on facts, not myths.

  • Myth 1: It's always a good time to invest in average.
    Truth: Passive outperformance and underperformance have historically moved in cycles.
  • Myth 2: Benchmarks follow sound investment strategies.
    Truth: Traditional benchmarks buy high and sell low by valuing companies based on how large they are instead of by their fundamentals or investment factors.
  • Myth 3: Benchmarks offer steady performance and less risk.
    Truth: Benchmarks have tended to underperform on the downside, and they can't actively avoid risk.
  • Myth 4: Benchmarks are effective substitutes for high-conviction strategies.
    Truth: Benchmarks simply provide market exposure, while high-conviction strategies can pursue a variety of goals.
  • Myth 5: Benchmark strategies always outperform active strategies.
    Truth: By their very nature, benchmarks cannot deliver alpha. They are simply a reflection of all market activity.

Getting smart about beta

The second publication in our Active/Passive Debate White Paper Series examines 10 types of smart beta strategies and analyzes how they performed over full market cycles and in different economic environments over the past two decades.

Our research shows that smart beta factors and methodologies outperformed the S&P 500 and MSCI EAFE indexes over multiple market cycles and in different economic climates. Our results also show that smart beta strategies generally outperformed market-cap-weighted indexes when adjusted for risk, while exhibiting lower downside capture ratios than market-cap-weighted indexes during most market cycles.

Smart beta results vs. the S&P 500 Index:

  • All of the five factors and five alternative weighting methodologies we tested resulted in higher absolute returns relative to the S&P 500 Index during the testing period.
  • The majority of smart beta strategies delivered higher risk-adjusted returns than the S&P 500 Index.
  • Favorable results were also seen when measuring downside capture in periods of weakness for the S&P 500 Index.

Smart beta results vs. the MSCI EAFE Index:

  • All of the factors and most of the alternative weighting methodologies we tested resulted in higher absolute returns relative to the MSCI EAFE Index during the testing period.
  • All of the factors and the majority of the alternative weighting methodologies delivered the same or higher risk-adjusted returns as the MSCI EAFE Index.
  • Favorable results were also seen when measuring downside capture in periods of weakness for the MSCI EAFE Index.

Smart beta strategies generally outperformed the S&P500 Index and MSCI EAFE Index during the study period


Source: FactSet Research Systems as of Dec. 31, 2015. Past performance does not guarantee future results. An investment cannot be made directly into an index. Index returns do not reflect any fees, expenses or sales charges.

Think active can't outperform? Think again.

Questions routinely arise about the value of active investing: Can active managers beat their benchmarks? Should investors abandon active strategies? Invesco conducted an extensive study of approximately 3,000 equity mutual funds over the past 20 years– covering five distinct market cycles– to investigate the true value of active management.

Individual investors often reduce "active" and "passive" to their simplest terms - active funds have portfolio managers who make investment decisions, and passive funds simply seek to replicate the holdings of an index. But as a way to gauge performance, those definitions are much too simple. Some active management teams may not stray very far from their benchmark. And some passive funds take a smart beta approach1, tracking innovative indexes that are constructed and weighted very differently than traditional, market-cap-weighted benchmarks. Other active managers may also take a smart beta approach by managing quantitatively enhanced index funds that seek added benefits for investors.

Key Findings:

Excess return. On an asset-weighted basis, 62% of high active share fund assets beat their benchmarks (after fees) across all market cycles. On an equal-weighted basis, 54% of high active share funds beat their benchmarks (after fees) across all market cycles.

Downside capture. Active management displayed significant outperformance in this area as well: 64% of high active share fund assets had a better downside capture than their benchmarks across all market cycles (62% on an equal-weighted basis). This evidence helps support our belief that active managers are better able to weather negative return environments than cap-weighted portfolios.

Risk-adjusted returns. When historical returns were adjusted for risk, active continued to outperform passive benchmarks: 62% of high active share fund assets had a better Sharpe ratio (providing more return per unit of risk) than their benchmarks (54% on an equal-weighted basis), across all market cycles. Even after adjusting for risk, actively managed portfolios performed better in aggregate compared to the results of passive benchmarks.


Downside capture: % of high active share assets and funds that captured less of the downside than their benchmarks


Source: FactSet Research Systems, Inc. Past performance is not a guarantee of future performance. An investment cannot be made directly into an index.

1 Smart beta is an alternative, index-based selection methodology that may outperform a market-cap-weighted benchmark or mitigate portfolio risk, or both, through active or passive vehicles. Smart beta funds may underperform cap-weighted benchmarks and increase portfolio risk. There is no assurance that an investment strategy will outperform or achieve its investment objective.