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Active Vs. Index Debate: In Search Of Evidence - Thursday, 04/04/2013

The lyrics of "I Can See Clearly Now," a 1972 hit song, came to mind recently when I was revisiting one investment theme that is commonly raised around this time of year as individuals prepare to pay their taxes and consider strategies for tweaking their portfolios: which performs better — active or passive management?

The "clarity" came in a biannual report published by S&P Dow Jones entitled "S&P Indices Versus Active Funds (SPIVA) Scorecard1." It threw some light on this interesting question.

In any given year, to varying magnitudes, benchmark indices outperform managers. In the year-end 2012 edition, the report indicates that in the General Muni Debt category, 29.03% of active muni funds were outperformed by the S&P National AMT-Free Municipal Bond Index2 for the 1-year period ending 12/31/12.

However, what caught my eye was data for the 3- and 5-year periods ending on the same date. For the 3-year period, 44.44% of general muni debt funds failed to outperform the S&P benchmark. And for the 5-year period, well more than half (60.00% of the funds) did not beat the index. (See table below.)

Percentage of Active Municipal Funds Outperformed by Benchmarks
Percentage of Active Municipal Funds Outperformed by Benchmarks Chart

Source: S&P Dow Jones Indices, CRSP. For periods ended Dec. 31, 2012. Outperformance is based upon equal weighted fund counts. All index returns used are total returns. Charts are provided for illustrative purposes. Past performance is not a guarantee of future results.

The concept that helped drive the development of index-based equity ETFs as well as the growing acceptance of indexed strategies appears to also have basis for the muni ETF market. While we must be careful not to generalize, this study does create a base for informed discussion on how to employ a muni investment strategy.

1The full report is available for download.

2The S&P National AMT-Free Municipal Bond Index is a broad, comprehensive, market value-weighted index designed to measure the performance of the investment-grade tax-exempt U.S. municipal bond market.




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Please note that MUNI NATIONs that are written by Jim Colby represent his opinions and these opinions may change at any time and from time to time. MUNI NATION is not intended to be a forecast of future events, a guarantee of future results or investment advice. Current market conditions may not continue. Non-Van Eck Global proprietary information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of Van Eck Global. MUNI NATION is a trademark of Van Eck Associates Corporation.

All indices listed are unmanaged indices and do not reflect the payment of transaction costs, advisory fees or expenses that are associated with an investment in the Fund. An index’s performance is not illustrative of the Fund’s performance. Indices are not securities in which investments can be made.

Any discussion of specific securities mentioned in the commentary is neither an offer to sell nor a solicitation to buy these securities.

Municipal bonds are subject to risks related to litigation, legislation, political change, conditions in underlying sectors or in local business communities and economies, bankruptcy or other changes in the issuer’s financial condition, and/or the discontinuance of taxes supporting the project or assets or the inability to collect revenues for the project or from the assets. Bonds and bond funds will decrease in value as interest rates rise. Additional risks include credit, interest rate, call, reinvestment, tax, market and lease obligation risk. High-yield municipal bonds are subject to greater risk of loss of income and principal than higher-rated securities, and are likely to be more sensitive to adverse economic changes or individual municipal developments than those of higher-rated securities. Municipal bonds may be less liquid than taxable bonds.

The income generated from some types of municipal bonds may be subject to state and local taxes as well as to federal taxes on capital gains and may also be subject to alternative minimum tax.

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