Active fund managers may sell themselves on being able to outperform the markets over the long term but few are currently beating their passive alternatives.
Research has revealed that only around a third of active fund managers have beaten the average passive fund performance in their sector during the first half of 2024.
It comes as investors will have been seeking returns to combat high inflation and borrowing costs, suggesting many could be wasting money on fund manager fees when they could earn the same or better returns with a passive fund.
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The findings come from AJ Bell’s latest Manager versus Machine report, which compares active fund performance with passive alternatives.
AJ Bell’s latest data for the first half of 2024 shows only 35% of active equity funds have beaten the average passive fund in their sector in 2024 – down from 36% at the end of 2023.
Meanwhile, just 35% have outperformed over 10 years.
That means investors could be better off putting money in a passive fund for most sectors rather than choosing an active fund. This trend is reflected by £89 billion coming out of active funds since the start of 2022 compared with £37 billion going into trackers.
However, performance can vary among index funds as well so investors still need to do their research to find the best fund.
“Active managers must be starting to feel like an endangered species. Not only is performance flagging, but passive funds are winning the battle for hearts, minds, and wallets,” says Laith Khalaf, head of investment analysis at AJ Bell.”
He describes the outflows from active funds as “a dark age” for the industry.
“They say if you can’t beat them, join them,” adds Khalaf.
“But then if active managers start mimicking indices with a large chunk of their portfolio, they lose their raison d’être, not to mention any sense of advantage over a plain vanilla tracker fund.”
Why are active fund managers struggling?
Much of the underperformance of active funds is attributed to the continuing popularity of technology stocks, particularly the rise of the Magnificent 7.
Global technology brands are dominating global and US markets, making it harder for active funds to compete, especially if they are not focused on this sector or are in different regions.
Just five companies were responsible for 46% of the returns of the S&P 500 index in the first six months of this year - Amazon, Apple, Meta, Microsoft and Nvidia, AJ Bell’s research shows.
Nvidia is responsible for 25% of the returns of the US benchmark.
“Failure to hold a market weight in the top performing technology stocks has therefore been a costly enterprise for active managers this year, and indeed over the last decade,” adds Khalaf.
He says an active US manager would have had to hold 28% in the Magnificent Seven stocks and 7% in each of Apple and Microsoft, simply to match the exposure of a passive fund.
“Those are pretty punchy portfolio positions for an active manager to adopt, with the unpleasing result they would simply be in line with the rest of the market,” he says.
“Consequently that part of the portfolio would perform just like the benchmark, and would legitimately lead investors to question why they are paying active fees for the privilege of index returns.”
When global and US funds are taken out of the data, the number of active equity funds outperforming a passive alternative over 10 years rises to a more respectable 46%, according to AJ Bell.
Things look worse overall amongst pension funds though where just 24% of active equity funds have beaten passive alternatives, with only 9% outperforming in the global sector.
The best and worst performing regions for active funds
The best region for active funds so far this year has been Asia Pacific ex Japan, according to AJ Bell.
Its analysis shows 62% of active funds outperformed their passive alternative.
The worst was the global sector, where just 26% of active funds outperformed.
Active fund performance is better on a five-year basis in some regions such as Global Emerging Markets, where 56% of active funds outperformed.
| Region | Year-to-date | Five years | 10 years |
|---|---|---|---|
| Asia Pacific ex Japan | 62% | 36% | 52% |
| Europe ex UK | 36% | 43% | 45% |
| Global | 26% | 15% | 19% |
| Global Emerging Markets | 49% | 56% | 53% |
| Japan | 36^ | 39% | 41% |
| North America | 35% | 21% | 22% |
| UK | 31% | 36% | 42% |
| Total | 35% | 30% | 35% |
Perils of passive investing
Passives may have done better in most sectors, but it is important to choose the right investment fund.
AJ Bell’s analysis found one fund tracking the FTSE 100 has turned £10,000 into £17,940 over 10 years, while another has offered up just £16,400.
“There are two main factors which explain the dispersion of passive fund performance,” says Khalaf.
“One is the index selected to be followed. This is by no means uniform within each equity sector, for instance in the Global sector, where over 10 years the S&P Global 100 index has trounced the MSCI World Index to the tune of over 80 percentage points.
“The other factor is charges. For two funds tracking the same index, the difference in return can largely be laid at the door of charges.”
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