Index Fund Adherents Point to S&P Scorecard

Standard & Poor's has just added more firepower to the debate over active management vs. index investing.

The novel way in which Standard & Poor's calculates performance data makes the results more meaningful for investors interested in how actively managed funds stack up against the relevant indices. The results will also offer a few surprises for those swayed by arguments that "we're in a stock pickers' market."

Introduced last week, the S&P Indices Versus Active Funds Scorecard, or SPIVA, provides both equal- and asset-weighted averages. The calculation also accounts for survivorship bias -- factoring in the performance of funds that were liquidated or merged, often because of weak performance.

Most performance comparisons are equal-weighted; that is, as a straight average. In other words, performance data from the $244 million (BGFIX Quote)William Blair Growth fund would count no differently than that of the $53.5 billion Fidelity's (FMAGX Quote)Magellan fund.

Asset weighting, though, takes into account the sizes of the funds averaged, and assigns a greater weight to larger funds. By weighing huge funds more heavily than small ones, asset-weighted figures demonstrate how a greater number of investors fared. "It takes into account what the investor experience really was," says Standard & Poor's mutual funds analyst Rosanne Pane.

In addition, asset-weighted averages help suss out the performance differences between large and small funds. For instance, in the past five years (incorporating both the best of the bull and worst of the bear markets), the S&P 500 lost 1.6%. In the same period, equal-weighted large-cap domestic equity funds lost 1.5%. The asset-weighted fund performance, though, lost 2.9% -- almost double the equal-weighted average.

Both the asset-weighted and equal-weighted averages correct for "survivorship bias." Frequently, over the course of a study, actively managed funds get merged or liquidated. If those funds were then to be eliminated or "backed out" of the study, the performance figures would be artificially high. S&P's calculation accounts for disappearing funds and tracks their performance all the way into oblivion.