Proponents of active management say that funds that don’t just track an index should outperform when markets start to fall. That hasn’t been the case.
found that about 40% of nearly 3,000 active funds outperformed their average passive peer over the 12 months through June. That success rate is worse than the 45% recorded in all of 2021, when markets were far less volatile.
Of course, in a bad market, almost all stock funds stand to be down. But the thinking goes that active funds should perform better in tumultuous times because their managers have the ability to buy and sell stocks as seems right at the time, or to hold on to their cash until they find a suitable investment. Morningstar’s data show that outperformance doesn’t always happen.
US large-cap funds are the key culprit. Only 34% of large-cap funds beat their passive peers, while active mid- and small-cap funds had respective success rates of 54% and 56%.
“We see active funds do best when there’s an illiquid market, said Bryan Armour, Morningstar’s director of passive strategies research. So-called information asymmetry in the small and mid-cap markets—the fact that not everyone learns what is going on at the same time—creates an opportunity for savvy managers that wouldn’t exist otherwise, he added.
Information on giant, high-growth tech companies like Apple (ticker: AAPL), Microsoft (MSFT), Alphabet (GOOGL), which are more liquid and heavily weighted in large-cap funds, is widely available. Flocks of analysts cover those companies, as do the news media.
Besides large-cap active funds, foreign stock active funds have also had a weak past year, with just 23% outperforming their average passive peer. This success rate is well below the 37% reported in 2021.
Although a one-year time horizon isn’t fair to draw sweeping conclusions, active funds didn’t fare much better even over the decade that ended in June. Morningstar’s analysis, which it performs twice a year, found that within that time frame, only 25% of active funds beat the average of their passive rivals. Those funds typically track the overall market, or a segment of it, thus providing a better post-expense return.
“It’s tough for active funds to find that alpha that can compensate for higher fees, especially in the US large-caps,” said Armour. The potential for alpha, or outperformance, is the main reason to buy actively managed funds.
Write to Karishma Vanjani at [email protected]