Active-Fund Investors: Do Your Homework
The underperformance of active funds, on average, versus passive means that investors need to aim for the best when choosing to go active.
The underperformance of active funds, on average, versus passive means that investors need to aim for the best when choosing to go active.
Tim Strauts: In today's chart, we are going to examine Morningstar's Active/Passive Barometer. It is unique in the pragmatic way it measures active-manager success. For instance, it compares active managers' returns against a composite made up of relevant passive index funds. We believe this is a superior approach because it reflects the actual net-of-fee performance of passive funds rather than an index, which isn't investable. What's more, the Active/Passive Barometer assesses active funds based on their beginning-of-period category classification so as to replicate the opportunity set an investor could have chosen from at the time. It does not purport to settle the active-passive debate. Rather, it aims to ground that debate with data that reflect investors' shared experience and to assess investors' odds of succeeding with active managers across asset classes, time periods, and fee levels.
The chart looks at one-, five-, and 10-year periods for U.S. equity funds. In each box, there are two numbers. The top number is the success rate, which is the percentage of active funds that outperformed the passive benchmark. The bottom number is the return of the passive benchmark over the period.
In the long run, active funds underperform their passive counterparts due to higher fees and trading costs. You'll notice that only two style boxes had a success rate of more than 50% for any period. In general, the one-year success rate is more volatile than the 10-year success rate. Over any short-term period, active managers will have a wide range of returns, which can lead to strong outperformance or underperformance versus the passive benchmark. Also, there is a correlation between success rate and performance of the category. Over the last year, the small-value style box has had the worst performance, but it has the highest success rate. This is because most active managers don't only hold small-value stocks in their portfolio; they likely has some mid-value and small core stocks, which helps the active manager outperform when small value has a bad year.
In conclusion, this analysis shows that, on average, active managers underperform. This doesn't mean that active management doesn't have a place in a portfolio but that an investor needs to look to other factors such as management fees, stewardship, and investment process to find the best active funds, which is what the Morningstar Analyst Rating seeks to capture.
Transparency is how we protect the integrity of our work and keep empowering investors to achieve their goals and dreams. And we have unwavering standards for how we keep that integrity intact, from our research and data to our policies on content and your personal data.
We’d like to share more about how we work and what drives our day-to-day business.
We sell different types of products and services to both investment professionals
and individual investors. These products and services are usually sold through
license agreements or subscriptions. Our investment management business generates
asset-based fees, which are calculated as a percentage of assets under management.
We also sell both admissions and sponsorship packages for our investment conferences
and advertising on our websites and newsletters.
How we use your information depends on the product and service that you use and your relationship with us. We may use it to:
To learn more about how we handle and protect your data, visit our privacy center.
Maintaining independence and editorial freedom is essential to our mission of empowering investor success. We provide a platform for our authors to report on investments fairly, accurately, and from the investor’s point of view. We also respect individual opinions––they represent the unvarnished thinking of our people and exacting analysis of our research processes. Our authors can publish views that we may or may not agree with, but they show their work, distinguish facts from opinions, and make sure their analysis is clear and in no way misleading or deceptive.
To further protect the integrity of our editorial content, we keep a strict separation between our sales teams and authors to remove any pressure or influence on our analyses and research.
Read our editorial policy to learn more about our process.