Why Can't Active Funds Beat the S&P? The Source of Return

Quick answer: they go flat or short. Either strategy is a loser. Why? The return of the S&P (and nearly ALL broad-based indexes) comes from a miniscule number of trading days that are very scattered and very unpredictable. The plot below shows the continuously compounded daily returns of SPY from its 1/29/1993 start date to 5/22/2024.

SPDR S&P 500 ETF Trust (SPY) closing price since 1/29/1993 adjusted for splits, dividends and capital gains distributions. Source: https://finance.yahoo.com/quote/SPY/

SPY has traded 7884 trading days or 31.28 years since inception. Here are the numbers:

CCROR = Continuously compounded rate of return (ln(day 2/day 1).

CAGR = Compound annual growth rate = sum of daily returns.

These are the returns from nonstop buy and hold for SPY from inception to 5/22/2024. These returns outperform 70% to 90% of all active managers, consistently, across nearly any time frame. See S&P's passive/active website here: 

https://www.spglobal.com/spdji/en/research-insights/spiva/about-spiva/

The total return of SPY (and QQQ and IWM, for that matter) is extremely sensitive to the top 10, 20, 100, etc. individual trading days. How sensitive is it? Here are the numbers:

The "Top" table shows how the SPY return changes when an active manager misses the top 10 SPY days. Just missing those specific 10 days reduces your return by 200 basis points (9.79% to 7.26%). Missing the top 20 days cuts you further and missing the 100 top days results in a sub TBill return!

Here are the top 10 and worst 10 days since inception for SPY:

Well what are the odds of that? Probably the chance of missing (or picking) the top 10 or 20 or any fixed number of top days is probably random but every day an active manager is OUT of the market, or worse yet, short the market, is another chance to miss a top day. Note that when tested for just random days, missing say 10 or 100 or 2000 random days (a much more likely scenario), there is much less effect on return.

Missing the "top 20 and worst 20" or any number of  like days also has a smaller effect on return. Returns only go up if you can miss the worst days and not miss the top days-a task as unlikely as any other. 

In sum, THE ONLY WAY TO GUARANTEE THAT YOU DON'T MISS TOP DAYS IS TO BUY AND HOLD.

If you can do it, more power to you, but public audited managers can't.