Active US Funds Lag Passive Rivals

The Morningstar Active/Passive Barometer measures fund managers’ success relative to the performance of passive funds after fees

Ben Johnson 26 March, 2018 | 12:43PM
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Wall Street Fund Management

The Morningstar Active/Passive Barometer was set up to answer the question: if an investor were to select an actively managed fund at random from a particular category, what are the odds that fund will survive and outperform its passive peers in any given time period?

The Barometer is a twice-yearly report that measures the performance of US active managers against their passive peers within their respective categories. It’s unique in the way it measures active managers’ success relative to the actual performance of passive funds after fees rather than an index, which isn’t investable.

We measure active managers’ success relative to investable passive alternatives in the same category. Specifically, we calculate the performance of index-tracking or passive options in each category, and we use that figure to define success or failure for the active funds in the same category.

We believe this is a better benchmark because it reflects the performance of actual investable options and not an index. Indices are not directly investable. Their performance does not account for the real costs associated with replicating their performance and packaging and distributing them in an investable format.

Also, the success rate for active managers can vary depending on one’s choice of benchmark. For example, the rate of success among US large-blend managers may vary depending on whether one uses the S&P 500 or the Russell 1000 Index as the basis for comparison. By using a composite of investable alternatives within funds’ relevant categories as our benchmark, we account for the frictions involved in index investing – such as fees – and mitigate the effects that might stem from cherry-picking a single index as a benchmark. The net result is a fairer comparison of how investors in actively managed funds have fared relative to those who opted for a passive approach.

We measure each fund’s performance then rank these composite fund returns from highest to lowest and count the number of funds with returns exceeding the average of the passive funds in the category. The success rates are defined as the ratio of these figures to the number of funds that existed at the beginning of the period. Given this unique approach, our field of study is narrower than others, as the universe of categories that contained a sufficient set of investable index-tracking funds was fairly narrow 10, 15, and 20 years ago. We expect that the number of categories we include in this study will expand over time.

Also, we divide categories along the lines of cost. Cost matters. Fees are one of the best predictors of future fund performance. We have sliced our universe into fee quartiles to highlight this relationship.

What Have We Found?

Actively managed funds have generally underperformed their passive counterparts, especially over longer time horizons. We also found that failure tended to be positively correlated with fees – that is, higher-cost funds were more likely to underperform or be shuttered or merged away, and lower-cost funds were likelier to survive and enjoyed greater odds of success. Again, fees matter. They are one of the only reliable predictors of success.

I think the Active/Passive Barometer is a useful starting point for investors when it comes to picking successful active managers and it is little surprise that focusing on fees is the best way to boost your performance.


The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Ben Johnson

Ben Johnson  is director of passive funds research at Morningstar.