The active versus passive debate has been raging for the past two decades. The biggest issue with active funds is fees. No investor should pay higher fees for sub-par performance. Still, if managers can outperform – earning their fees and then some extra – it is a good deal for investors.
However, it is difficult to dispute that passive funds beat active ones on average over the long run. The S&P Indices Versus Active (Spiva) reports from S&P Dow Jones consistently show that active funds have lagged behind relevant benchmark indices over long periods. Among US-based large-cap US equity funds, 64% have underperformed the S&P 500 over the past 24 years. In Europe, 93% of funds underperformed the S&P Europe 350 over ten years, while 82% of UK funds have lagged behind the S&P United Kingdom BMI.
The Morningstar active/passive barometer uses a slightly different approach of comparing active funds with passive funds in the same category, since this takes account of the reality that passive funds are not a perfect, cost-less replication of an benchmark index. Still, the results are very similar. Just 14.2% of active funds based in Europe beat passive strategies over the past ten years. Again, for large-cap equities, active fund performance has been particularly poor, making it “increasingly difficult to justify their higher fees”.
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So the key is to find the areas where active managers still have the edge. For example, Morningstar notes that small-and mid-cap equities all saw active managers perform better: for example, 33% of managers investing in US small caps and 36% of investors in eurozone small caps beat passive peers.
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This is still not a majority of funds. However, at least it suggests that investors are less likely to be wasting their time looking for an active manager who can add value here. So there is a stronger case for using active funds tactically in particular markets or sectors.
Standing out
Pickafund is a new fund-comparison platform set up by a group of former traders from Credit Suisse and Morgan Stanley that aims to demystify this area. It has been designed to bring together data on funds from across the market – investment trusts, exchange traded funds (ETFs), open-ended investment companies (OEICs) and unit trusts – without having to deal with broker’ restrictions that limit which funds are on each platform. This is very helpful with smaller, niche funds.
One of the latest features is the active/passive fund comparison: a daily-updated page that tracks how active funds are performing relative to their passive counterparts.
The data only currently stretches back five years, but there’s a ten-year screener in the works.
The results suggest that there is no point in investors trying to seek outperformance with an active manager in well-covered markets. For example, in the global large-cap sector, the platform has 258 active funds with a track record of five years, compared with 65 passive funds. On average, the median net total annualised return for the active funds is 8.6%, compared with 11.5% for passives.
More surprisingly, be careful in emerging markets – an area where many investors believe that active managers can readily succeed because markets are less efficient. The platform has 40 passive funds and 201 actives in the emerging markets equity category. Yet the actives have still underperformed passives by 0.17% annualised (on a median basis) over the past five years.
In the least-efficient markets, the odds may start to improve. The six active funds focusing on Africa and the Middle East have outperformed the one passive fund by 3.95% annualised over five years, on average. Active funds focusing on India have outperformed by 2% annualised, while those in frontier markets (ten active funds and two passives) have outperformed by 4.3% annualised. Similar trends can be seen in other categories that involve more small caps and in specialist markets such as biotech and alternative energy.
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