Fewer than a third of fund managers outperformed passive funds last year but it was worth paying for one in some regions, research suggests.
Investors faced plenty of stock market volatility during 2023 with high inflation and rising interest rates and many will have relied on active fund managers to provide sustainable returns and hopefully outperform the market.
But in many cases, fund managers struggled to justify their fees and underperformed compared with passive alternatives, especially where markets did well.
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Research by Morningstar has shown that across 38 equity categories, just 31.2% beat passive funds as of December 2023.
The research firm’s Active/Passive Barometer compares 26,600 active and passive Europe-domiciled funds that account for approximately €6.9 trillion in assets, or about half of the total European fund market
Over 10 years the figure drops even lower to around 17%.
It comes after the latest Spot the Dog research from Bestinvest showed an increasing number of underperforming active funds, while AJ Bell’s latest Manager v Machine report shows these types of funds are also struggling.
Experienced investors will understand that past performance is not necessarily an indicator of future returns but there is little point in paying the higher fees for an active manager if a passive alternative is regularly performing better.
We reveal the areas where active managers have performed better or worst against passive funds.
Active v passive fund performance
It can be hard for fund managers to beat the market when stock markets are doing well. Investors will automatically benefit when share prices are rising but it means they may not be getting much extra on top of what a passive fund will offer.
In contrast, it is when markets are falling that active managers really earn their money to maintain a steady performance and hopefully generate a return or at least limit losses.
One of the major areas that fund managers struggled last year was in the US.
The S&P 500 hit record highs during 2023, helped by a boom in technology stocks mainly around the Magnificent 7.
This has helped passive strategies, making it hard for active managers to outperform.
In the US large-cap blend Morningstar ategory, 41.9% of active US equity funds outperformed their passive competitors in the year to the end of December 2023.
However, over a decade, the case for passives for this market exposure is stronger, with only 6.3% of active funds beating the passive alternative.
European equity markets also outperformed last year.
This meant euro-centric active managers in the eurozone large-cap category struggled, with only 23.9% beating their passive counterparts by the end of December 2023 and a 10-year success rate at a mere 11.1%, according to Morningstar.
In contrast, the UK stock market lagged other indices last year amid high inflation and fears of a recession, but this was actually good news for active fund managers.
In the UK large-cap category, 63.5% of stock-pickers managed to outperform passive funds over the 12 months ended in December 2023. However, their long-term success rate over a 10-year span is significantly lower at 20.5%.
Another area where active management may have been worth the fee was equity income.
The one-year success rate for active managers in the global equity income category was 62.2%. Over 10 years, active managers also had a high success rate of 52.3%.
“Passive funds have underperformed their active counterparts in this category largely because they emphasize value and small-cap stocks," says Morningstar.
"Over the past decade, the market has favoured growth and larger companies, which has naturally impacted the performance of passive strategies in this arena."
In emerging markets, the one-year and 10-year success rates for active managers in the India equity category were 64.3% and 53.5%, respectively.
Morningstar says this was because passive funds in this category also tend to have a large and mega-cap bias, “making them an imperfect tool to access the broader Indian equity market.”
The analyst firm says: “This focus exposes investors to significant single-stock concentration risks and leaves ample room across the market-cap spectrum for active managers to add value.”
In China, which continued to reopen its economy and battled deflation in 2023, the one-year success rate for active managers in this category is 46.3%, while the 10-year success rate stands at 27.4%.
“Generally, active managers tend to achieve higher success rates within mid-cap and small-cap equity categories compared with those focusing on large-cap stocks,” says Morningstar.
“Additionally, active funds are more likely to succeed in equity categories where the average passive counterpart exhibits a structural bias toward a particular economic sector or is concentrated on a few individual names.”
