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Active vs. Passive Fund Performance: 5 Learnings from the Second Half of 2019

Active small-cap funds saw a big rebound in one-year success rates, and more from the latest Morningstar Active/Passive Barometer.

Success rates among active U.S. stock funds increased relative to 2018: 48% of these funds survived and outperformed their average passive peer in 2019, versus 38% in 2018.

These findings and more are detailed in the Morningstar Active/Passive Barometer, a semiannual report that measures active vs. passive fund performance within their respective Morningstar Categories. The barometer is unique in the way it measures active managers’ success relative to the actual, net-of-fee performance of passive funds rather than an index, which isn’t investable. You can learn more about the methodology of the report in our previous blog post, “How Actively and Passively Managed Funds Performed: Year-End 2018.

Here's a look at a few of the main findings from the report.

enter image description here 5 Takeaways About Active vs. Passive Fund Performance From Our Year-End 2019 Report

  1. Active funds’ one-year success rates increased versus 2018 in 14 of the 20 categories we examined. Altogether, around 47% of active funds beat the passive composite for their category in the 12 months through December 2019. Year-over-year changes in active funds’ one-year success rates are shown on the chart below. enter image description here

  2. Among U.S. stock-pickers, active small-cap funds saw the biggest rebound in one-year success rates. As shown on the chart below, 57% of these funds beat the average of the passive funds in their categories in 2019, up from 32% in 2018. Over the course of 2019, the gap between large- and small-cap stocks’ performance widened to twice its 2018 size. This helped to lift the success rates of small-cap managers, who tend to favor large-cap names. enter image description here

  3. The one-year success rate for active funds in the corporate bond category plummeted in 2019. These funds were hurt by having generally riskier credit profiles and shorter durations than their passive peers, especially during a year when higher-quality credits outperformed and interest rates declined.

  4. The distribution of 10-year excess returns for surviving active funds versus the average of their passive peers varies widely across categories. As shown on the chart below, it skews negative for U.S. large-blend funds. Considered in combination with success rates, this indicates that the likelihood of picking an underperforming manager, and the potential penalty for doing so, tends to be greater than the likelihood of finding a stronger performer and being able to earn those potential rewards. The inverse tends to be true of the fixed-income and foreign stock categories we examined, where excess returns among surviving managers skewed positive over the past decade. enter image description here

  5. On a positive note, our data suggests that the average active dollar has outperformed the average active fund. This implies that investors have favored cheaper, higher-quality funds.

Still, many active managers’ long-term track records leave much to be desired. In general, actively managed funds have failed to survive and beat their benchmarks, especially over longer time horizons. That said, there are some categories where investors have better odds of picking successful active funds and the prospective payout profiles are more attractive.

This blog post is adapted from research that was originally published inMorningstar Direct™. If you’re a user, you can `access the full paper. If not, take a free trial.

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