Brutal market performance in 2022 reignited the narrative that active funds can better navigate market turmoil than passive peers. Despite an uptick in success rates by U.S. stock-pickers, the latest evidence debunks these claims yet again. As Warren Buffett once said, “only when the tide goes out do you discover who’s been swimming naked.” In 2022, it turned out that active bond and real estate funds were caught skinny-dipping.
Of the nearly 3,000 active funds included in our analysis, only 43% survived and outperformed their average passive peer in 2022. We further analyze these findings in the year-end 2022 installment of the Morningstar Active/Passive Barometer, a semiannual report that measures the performance of U.S. active funds against passive peers in their respective Morningstar Categories. The Active/Passive Barometer spans nearly 8,400 unique funds that accounted for approximately $15.7 trillion in assets, or about 65% of the U.S. fund market, at the end of 2022. The full report can be found here.
You can learn more about the background on our approach to the report in this article.
Most Active Managers Have Failed to Capitalize on Volatility
When viewed as a whole, active funds had less than a coin flip’s chance of surviving and outperforming their average passive peer in 2022, although results varied widely across asset classes and categories. For example, U.S. stock-pickers handled volatility much better than foreign-stock funds. The former cohort outgained its average passive peer 49% of the time in 2022, while only 34% of the latter group succeeded.
Overall, active bond funds had a rough year, with just 30% besting their average index peer last year. The one-year success rate for active managers across the three fixed-income categories dropped 42 percentage points from their mark in 2021. Active managers had a tougher time in corporate bonds (23% success rate) than intermediate core bonds (38%). Exhibit 1 details the year-over-year change in success rate by category from 2021 and 2022.
But one year isn’t a sufficient time horizon from which to draw conclusions. Success rates can fluctuate wildly from year to year, depending on what’s going on in the markets and how that reflects on the actively managed portfolios as well as in the passive funds that we measure them against. For example, many active bond funds tend to take more credit risk than their index peers. Their success rates tend to rise when this risk is rewarded and fall when credit spreads widen, as they did last year.
Longer horizons provide stronger signals that investors can incorporate into their selection processes. In general, actively managed funds have failed to survive and beat their benchmarks, especially over longer time horizons. Only one out of every four active funds topped the average of their passive rivals over the 10-year period ended December 2022.
But success rates vary across categories. Long-term success rates were generally higher among bond, real estate, and foreign-stock funds, where active management may hold the upper hand. Investors can use this data to identify areas of the market where they have better odds of picking winning active funds.
Sizing Relative Performance of Passive and Active Investing
Success rates alone only tell half the story. The other half is the prospective payoff for choosing a winning fund and the penalty for picking a loser. The Active/Passive Barometer provides this information by plotting of the distribution of 10-year excess returns for surviving active funds versus the average of their passive peers.
Much like success rates, these distributions vary widely across categories. In the case of U.S. large-cap funds, the distributions skew negative. This paints a bleak picture for active funds in these categories. They have low long-term success rates, while penalties are high for picking a loser (per the negatively skewed distribution).
The opposite tends to be true of fixed-income, real estate, and certain foreign-stock categories, where long-term success rates have generally been higher and excess returns among surviving active managers skewed positive over the past decade. Exhibits 3 and 4 show the distributions of excess returns for surviving active funds from the large-blend and diversified emerging-markets categories.
Costs Matter for Both Passive and Active Strategies
The signal that rings loud and clear in this dataset is that fees matter. The cheapest funds succeeded more than twice as often as the priciest ones (36% success rate versus 16%) over the 10-year period through 2022. This not only reflects cost advantages but also differences in survival, as 67% of the cheapest funds survived, whereas 59% of the most expensive did so.
If there’s one near certainty for investors, it is “you get what you don’t pay for,” as the Vanguard’s late founder Jack Bogle said.
The author or authors do not own shares in any securities mentioned in this article.Find out about Morningstar’s editorial policies.
In 2023, actively managed mutual funds and ETFs fell short of their passive peers. While notching an improvement over 2022, slightly less than half (47%) of active strategies survived and delivered higher net-of-fees returns than their average passive counterpart.
In simple terms, active investors attempt to outperform the returns of a specific benchmark, whereas passive investors accept the market return by tracking a specific index.
Passive investing is buying and holding investments with minimal portfolio turnover. Active investing is buying and selling investments based on their short-term performance, attempting to beat average market returns. Both have a place in the market, but each method appeals to different investors.
Another driver of the underperformance of active funds, according to McDermott, is fees: “All funds have years where they underperform, however, the longer-term evidence is undeniable that active managers have continued to struggle. The main reason for this underperformance is because active funds charge higher fees.”
Long-term trends and low costs can help investors decide between active and passive funds. The script flipped from value to growth in 2023, but the narrative stayed the same for active managers. Of the nearly 3,000 active funds included in our analysis, 47% survived and outperformed their average passive peer in 2023.
The rise of index funds has provided millions of Americans with a cheaper and more efficient way to invest. With more than $23 trillion in assets between them, BlackRock Inc., Vanguard Group Inc.and State Street Corp. have become the top shareholders in many US-listed companies.
Risk: Active funds have a higher risk than passive funds, as they are subject to the fund manager's skill, judgment, and errors. Passive funds have a lower risk than active funds, as they eliminate the human factor and closely mirror the index, resulting in lower volatility and tracking error.
The downside of active investing is there is no guarantee that active funds will outperform their benchmark, particularly once the higher fees are taken into consideration.
Mutual funds following an active investment strategy aim to outperform their benchmark indices by selecting undervalued stocks or capitalising on market trends. This strategy appeals to investors who seek higher returns and are willing to navigate higher risks.
International developed stock fund managers were able to beat their respective indexes in four of the past 23 years, or 17.4% of the time. Meanwhile, emerging markets active fund managers fared even worse. They only managed to outperform in two years, or 8.7% of the time, during these 20-plus years.
Passively managed investments typically have lower expense ratios and management fees compared to actively managed investments. This cost advantage can lead to higher net returns for investors.
Investors can easily rack up high fees, as well as capital gains taxes, that make many actively managed funds a poor alternative to passively managed strategies that can mimic a benchmark at a lower cost. Still, actively managed funds can have a better chance of outperforming during periods of volatility.
Less than 10% of active large-cap fund managers have outperformed the S&P 500 over the last 15 years. The biggest drag on investment returns is unavoidable, but you can minimize it if you're smart. Here's what to look for when choosing a simple investment that can beat the Wall Street pros.
Although it is very difficult, the market can be beaten. Every year, some managers boast better numbers than the market indices. A small fraction even manages to do so over a longer period. Over the horizon of the last 20 years, less than 10% of U.S. actively managed funds have beaten the market.
Active equity funds rely on managers' decisions, while passive funds attempt to track indices efficiently. As per SPIVA, five out of 10 large-cap funds underperformed the S&P BSE 100, while over 73% of mid- and smallcap schemes lagged the S&P BSE 400 MidSmallCap in 2023.
Risk: Active funds have a higher risk than passive funds, as they are subject to the fund manager's skill, judgment, and errors. Passive funds have a lower risk than active funds, as they eliminate the human factor and closely mirror the index, resulting in lower volatility and tracking error.
Less than 10% of active large-cap fund managers have outperformed the S&P 500 over the last 15 years. The biggest drag on investment returns is unavoidable, but you can minimize it if you're smart. Here's what to look for when choosing a simple investment that can beat the Wall Street pros.
More than a third of active equity managers outperformed passive counterparts over the last one-year period. Active bond managers did even better, with 62.7% on average outperforming their passive alternative.
Introduction: My name is Horacio Brakus JD, I am a lively, splendid, jolly, vivacious, vast, cheerful, agreeable person who loves writing and wants to share my knowledge and understanding with you.
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