Passive funds beat active funds yet again

Investors are racing to ditch active funds for passive funds. When you compare performance, it’s clear why.

916_Strategy

Passive funds those which aim to track the market rather than beat it are currently trouncing active funds (which do try to beat the market) when it comes to popularity with investors. Last year, in the US, $692bn flowed into passive funds, while roughly $7bn flowed out of actively-managed funds. In other words, active funds are losing investors overall.

This has resulted in something of a backlash from active managers. We keep hearing tales of how passive funds might be distorting the market, or complaints that they won't look after investors when the next bear market arrives. Yet, when you compare the results that active managers achieve over time with those of index trackers and other passive funds, it's very clear why passive investing has become so popular. The simple truth is that it's very difficult for an active fund manager to beat the market, and we now have yet another in a long line of studies that rather proves the point.

Data provider Morningstar looked at nearly 9,500 European active and passive funds over the ten years from June 2008 to June 2018, notes Attracta Mooney in the Financial Times. Morningstar split these into 49 different categories (some of which are fairly niche, as Financial News point out, such as investing in Canadian or Korean stocks). Of the 49, there were only two where the majority of active managers managed to beat their passive peers. Incidentally, those two categories were UK mid-cap equity funds (where more than 75% of active funds both survived and managed to beat the average passive fund) and Norwegian equities (where the figure was just under 60%). The worst performer, by contrast, was US large-cap "growth" equity funds, where less than 1% of active funds lasted for ten years and also managed to beat the average passive fund. And lest you imagine that the bond market is any different, just 3.4% of active funds investing in US diversified bonds managed to win out over ten years.

When faced with odds like that, you can see why investors increasingly favour passive funds. Why pay more for active management if the odds are that you'll underperform a cheap passive alternative? We're not saying that all active management is a waste of money. And we are particularly keen on investment trusts, whose structure is more conducive to long-term investment (and which tend to do better than traditional unit trusts). But if you are going to pick an active fund over a passive one, then you need good reasons for doing so. If you can't explain why you think an active fund will do a better job than a passive tracking the same benchmark, stick with the passive every time.

Recommended

Great frauds in history: Carlton Cushnie’s befuddling Ponzi scheme
People

Great frauds in history: Carlton Cushnie’s befuddling Ponzi scheme

Carlton Cushnie set up a finance company which was valued at an estimated £230m, but made only one trade finance loan in its existence, which actually…
28 Oct 2020
The MoneyWeek Podcast: How the Law Debenture Corporation's unusual structure gives it an edge
Investment trusts

The MoneyWeek Podcast: How the Law Debenture Corporation's unusual structure gives it an edge

Merryn talks to Dennis Jackson and James Henderson of the Law Debenture Corporation about what makes the trust unique, the regulatory tailwinds it can…
27 Oct 2020
Being unpopular can make life easier for companies – just ask BP and HSBC
Investment strategy

Being unpopular can make life easier for companies – just ask BP and HSBC

When you're as hated as banking and the oil sector, it doesn't take much to pull off a nice surprise. John Stepek explains what that means for investo…
27 Oct 2020
Nine of the best new investment trusts and ETFs
Funds

Nine of the best new investment trusts and ETFs

A lot of appealing investment trusts trusts and exchange-traded funds have emerged now that the market has calmed down. David Stevenson picks nine of …
26 Oct 2020

Most Popular

The Bank of England should create a "Bitpound" digital currency and take the world by storm
Bitcoin

The Bank of England should create a "Bitpound" digital currency and take the world by storm

The Bank of England could win the race to create a respectable digital currency if it moves quickly, says Matthew Lynn.
18 Oct 2020
Don’t miss this bus: take a bet on National Express
Trading

Don’t miss this bus: take a bet on National Express

Bus operator National Express is cheap, robust and ideally placed to ride the recovery. Matthew Partridge explains how traders can play it.
19 Oct 2020
Three stocks that can cope with Covid-19
Share tips

Three stocks that can cope with Covid-19

Professional investor Zehrid Osmani of the Martin Currie Global Portfolio Trust, picks three stocks that he thinks should be able to weather the coron…
12 Oct 2020