Active funds beat passive funds, until you factor in fund fees

The outperformance of active funds is flattened once the average active fund fee of 1% is included. 

Funds and Investment Trusts January 11, 2019 by Tom Bailey

Active funds that invest in shares have a slightly higher gross performance than their passive investment counterparts, according to the European Securities and Markets Authority’s (ESMA) first annual report on cost and performance of retail investment products.

However, the paper points out, that outperformance disappears as soon as the fees of actively managed funds are factored in. As the paper notes: “Actively managed equity funds provide a slightly better gross performance than passively managed funds, even though the margin is small.”

Using a sample of 2.4 trillion euro open-ended fund universe at the end of 2017, the paper shows that gross returns for active funds over both a one year and three year period were around 1% higher for active funds compared to passive.

However, that outperformance is flattened once the average active fund fee of 1% is included. In contrast, passive funds were found to have an average fee of 0.6%. Over a longer time horizon, performance for active funds begins to slip below those of passive funds.

The paper concludes: “Actively managed funds clearly produce higher costs to investors than their passive peers, while equating them in terms of gross annual performance or even underperforming.”

Of course it is important to note that the performance of active funds is an average, meaning some funds have and do provide performance above that of passive even with fees factored in. The problem, however, is attempting to identify funds that will continue to beat market averages, which is by no means an easy task.

Added to this, many managers that beat the market only do so for a limited amount of time, either because either their investing style and strategy has fallen out of favour or simply their luck has run out.  

For an attempt to identify active funds (and trusts) that should provide above average performance, we’ve constructed our yearly Rated Funds list. Read more about it here.

The paper also found that the adoption of passive investment strategies across the EU varies widely per country.

Over the past five years, the share of passive funds averaged around 10% of the total EU equity funds. However, in some EU member states such as Italy and France, the use of passives has been negligible. In contrast, in Luxembourg, Sweden, Ireland and the United Kingdom, passives account for between 10% and 30%.

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