Morningstar, a leading provider of independent investment research, has introduced the Active/Passive Barometer, a report on the relative performance of actively managed and passively managed funds. The inaugural report shows unequivocally that US active managers have struggled to outperform passive trackers, such as exchange-traded funds, over the last 10 years.
The majority of US active managers have lagged passive fund returns
The active-versus-passive debate stretches back decades with many academics finding strong evidence that active managers fail to add value after fees.
Considering the strong inflows over the past decade into ETFs, which are overwhelmingly passively managed products, investors appear to be in agreement.
Indeed, data from industry consultants ETFGI shows that assets invested in ETFs and ETPs have tripled from $1 trillion to $3 trillion globally in the past six years alone.
Morningstar’s report provides investors with a practical measurement tool to assess the net-of-fees performance of active US fund managers against the returns achieved by comparable passive funds.
The report shows that active funds have failed to outperform passive returns across nearly all asset classes and categories over the past 10 years.
It is clear from the report that cost plays an important role in an active manager’s ability to beat their passive competition. Low-cost active funds were shown to be more likely to survive and outperform, but the numbers are far from complimentary with low-cost active funds failing to beat their benchmarks, on average, across nine of the twelve categories.
Within equities, low-cost active US mid-cap value funds had the highest success rate, at 68.2% for the 10-year period, while high-cost active mid-cap blend funds had the lowest success rate, at nearly 5%.
Active funds investing outside the US fared better than their US counterparts with 40.2% of international large-cap blend funds beating the average passive fund, nearly double that of US large-cap funds. This supports the claim that the relative efficiency of US markets, a product of the highly competitive nature of active management in the region, makes beating the benchmark more difficult.
The underperformance of US active managers has driven a surge of inflows into products managed passively against US indices, particularly ETFs, as well as smart beta products which are viewed as a cost-effective alternative to active management. As recently seen in the S&P DJI data, ETF assets based in their indices grew 24% year-over-year, while products based on their smart beta indices were up 55%.
Beating the benchmark appears to be more attainable within fixed income as 69.7% of intermediate-term bond funds managed to provide superior returns over the trailing 5-year period. The US equity category, in comparison, managed a less than 50% success rate during the same period.
The Morningstar report is released semi-annually and calculates the percentage of actively managed funds that have survived and generated returns ahead of the average passive fund. The returns reflect the actual, net-of-fee performance of the funds and are compared across a range of Morningstar categories.
Ben Johnson, Morningstar’s director of ETF research, commented: “Our approach is squarely focused on the performance of actual investable options, instead of an index. We’re also replicating the investor experience by studying funds based on their category classification at the beginning of the time period, controlling for survivorship, and taking into account the importance of fees.”
Morningstar’s report clearly highlights the disappointing relative performance that active managers have achieved over the past decade and the ease at which investors could have generated superior returns through the use of low-cost, diversified, passive vehicles such as ETFs.