A new Morningstar report may add some fuel to the active/passive investment debate.
In general, Morningstar finds that actively managed funds have failed to survive and beat their benchmarks, especially over longer time horizons. Moreover, based on data from its “Active/Passive Barometer” (which spans approximately 3,500 unique active and passive U.S. funds that account for approximately $10 trillion in assets, or about 60% of the U.S. fund market), a new report notes that “investors would greatly improve their odds of success by favoring low-cost funds, which succeeded far more often than high-cost funds over the long term.”
However, the report notes that, with respect to recent trends in active funds’ success:
- When compared with the 12-month period ended June 30, 2016, active funds’ success increased “substantially” in 10 of the 12 categories examined in the year ended June 30, 2017.
- The one-year success rate among active U.S. equity funds increased substantially relative to year-end 2016. Nearly half (49%) of active U.S. stock funds beat their composite passive benchmark in the 12-month period ended June 30, 2017, versus 26% for the year ended Dec. 31, 2016.
- Funds with a value bent witnessed a sharp increase in their one-year success rate: Active funds in the large-, mid- and small-value categories had a combined success rate of 57% relative to their passive peers over the past 12 months.
- Among active U.S. stock funds, the success rates of small-blend funds slid the most. Only 32% of active funds in the category beat their benchmark over the 12 months through June 2017, versus 46% in the year-ago period. Active small-value and small-growth funds fared “materially better,” according to the report, with about 56% and 61% beating their composite index, respectively, over the same span.
- More than 80% of active funds in the intermediate-term bond category survived and outperformed their composite index in the 12-month span ended June 30, 2017. The report notes that active managers in the category have been rewarded handsomely for assuming credit risk as both investment-grade and below investment-grade credits have rallied.
Stylistic headwinds and tailwinds tend to explain short-term fluctuations in active-fund success, according to the report’s authors. That said, only two categories have more than half of the active funds tracked by Morningstar that outperform their respective composite benchmarks over the three- and five- year periods — diversified emerging markets and intermediate-term bond. And none has more than half of its constituent funds outperforming over the 10-, 15- or 20-year spans.
Fees can obviously make a difference; in the 10-year timeframe, the lowest-cost quartile of active funds had a higher proportion of offerings outperforming their passive benchmarks than those in the highest-cost quartile across all categories, save one (U.S. small value).