Active funds have underperformed passive in all but two sectors

Passive funds have generally beaten active funds over the past decade, even in 'less researched' emerging markets. 

Funds and Investment Trusts October 1, 2018 by Tom Bailey

Do passive index trackers offer solid returns for a low price, or are they asking investors to accept mediocrity in their portfolio? The latter, say active managers and their supporters; instead, they promise that skilfull stockpicking can provide market-beating returns. Fans of passive respond sceptically, noting that the actual track records of most active managers are more patchy. 

According to Morningstar’s latest research, over the past 10 years those in the passive camp have primarily been correct.

Looking at the performance of Europe-domiciled active funds against passive peers in their respective Morningstar categories between 2008 and 2018, active managers survived and outperformed their average passive peers in just two of the 49 categories.

At the same time, over the past 10 years, active managers' ‘success rate’ was less than 25 per cent in more than half of the categories surveyed. The success rate is defined by Morningstar as the percentage of funds that went on to survive as well as generate returns in excess of passive fund returns over a specific period.

As might be expected, the success rate for active funds differed according to region, with certain markets seeing much higher success rates than others.

Some areas saw the majority of active managers consistently underperform. For instance, the US large-cap growth equity category saw a success rate of just 0.7 per cent, while US large-cap blend saw a success rate of 12.4 per cent. Canada equity had a success rate of 11.1 per cent, while US-dominated global large blend equity saw a success rate of 11.5 per cent.

The low success rates in these markets confirms a point often made in the active versus passive debate: active management tends to provide markedly lower returns in heavily researched markets.

Markets such as the US have large number of analysts covering most publicly listed companies, meaning prices often reflect the latest news. This limits the ability of active stockpickers to find underpriced shares and provide market-beating returns.

However, while active funds did better in less-researched markets, success rates were still less than 50 per cent, suggesting active has less of an edge over passive in supposedly under-researched markets than often thought.

For instance, the India equity category had a 10-year success rate of 10.3 per cent, while China equity’s was 40.5 per cent. Latin American equities saw an even worse success rate of just 27.8 per cent over the decade.

Indeed, the only two sectors to have success rates above 50 per cent were Norway equity and UK mid-cap equity.

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