Emma Wall: Hello, and welcome to the Morningstar series, "Ask the Expert." I'm Emma Wall and I'm joined today by Ben Johnson, Morningstar's Global Director of ETF Research.
Hi, Ben.
Ben Johnson: Hi, Emma.
Wall: So, we're here today to talk about where active management and where passive fund management excel, and there's a really interesting study that you and your teams do called the Active/Passive Barometer. What is that study?
Johnson: Well, the Active/Passive Barometer is a way of measuring the success of active managers. And the yardstick that we use to measure their success or lack thereof in many cases is a composite of all of the various index-tracking funds, inclusive of both trackers as well as exchange-traded funds, that are available to investors in various Morningstar categories.
So, this compares active managers and active management versus real investible options that are available to investors of all stripes as an alternative.
Wall: And I think that's really interesting because quite often we say compared to a benchmark. But actually, the benchmark isn't always investible. What you are doing here is you are really saying, hey, the individual investor has these two choices or myriads of choices, I should say, and which is the best one for them. So, the European study was one of the most recent. What were the high-level findings?
Johnson: Well, at a high-level what we found in our European study really resonates with studies we've done in all corners of the globe to-date, which is that, first and foremost, active management is a difficult task, a daunting task, that most active managers fail to survive from the beginning of any given period to the end, that their odds of even surviving decline over time.
So, over the 10-year lookback in our European study the biggest sort of defining sort of rod between success and failure was just simply survival, that most funds that fail to live for any given period of time, that they are either shuttered or merged into other funds.
Even amongst those that survive, many fail to thrive. It's exceedingly difficult for active managers, especially if they are charging higher fees to outperform their index peers over long periods of time. Index funds have one source of durable competitive advantage relative to active managers which is manifested in many cases in their very low fees, which are really by all of their work that we've ever done that others have done, the only real reliable predictor of future success amongst funds is fees.
Wall: And I suppose one positive thing to take from this going forward is we are seeing fee compression across the active fund space that perhaps in 10 years' time looking back it won't be quite so dire set of results. Because I believe less than 25% of active managers beat their passive peers.
Johnson: If you look at half of the 49 categories that we studied in Europe, that's exactly the case, that less than a quarter were able to survive, again and outperform their passive peers, which is pretty grim if you are an investor looking to select active managers. That's not to say that there aren't good ones out there.
Again, investors can improve their odds of finding winners by first and foremost focusing on those that charge lower costs and also being selective in terms of the categories where active managers have better odds.
So, if you look across those 49 categories that we examined, there are certain areas of the market where investors had above average odds of success. Of note, one in particular being the U.K. mid-cap category where nearly three quarters of active managers, both survived and outperformed their passive peers over long timeframes.
Wall: Ben, thank you very much.
Johnson: Thanks for having me.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
