Active vs. passive fund management

[magellan1]

Undoubtedly, asset management is one of the most attractive sectors of Finance and many people dream to work for reputable asset managers like Schroders or Amundi.
Most professionals who work in the industry believe that they are very capable and can outperform benchmarks in the same way as most drivers believe that they are above average. However, it is actually not possible for most people to be above average and the data on the performance of active vs passive funds clearly shows that.​

Share of active funds that outperform passive funds by geography​

Region​	5 Years​	10 Years​	Change​
Asia-Pacific, ex-Japan​	47%​	59%​	-12%​
Europe, ex-UK​	46%​	57%​	-11%​
Global​	26%​	28%​	-2%​
Emerging markets​	37%​	42%​	-5%​
Japan​	43%​	51%​	-8%​
North America​	25%​	28%​	-3%​
UK​	31%​	63%​	-32%​
All​	33%​	45%​	-12%​

Source: AJ Bell, Morningstar. Data as of 30th June 2022​

According to the data, 55% of active funds have underperformed index funds over the last 10 years and the share of underperforming funds continues to increase (67% over the last 5 years). The underperformance of the North American and Global active funds is even more striking. Asia Pacific and Europe are the only regions where active investing might still work.
Unsurprisingly, in 2021 the passive fund ownership of US stocks has overtaken the ownership by actively managed funds and the shift from active to passive is likely to continue in the future. This is not very encouraging for people who dream to work as portfolio managers at active funds since the number of available positions is declining.

Are stock-picking and active fund management dead? Do you prefer investing in active or passive funds? Will the performance of active funds improve in the future?​

 

[HowardM1]

There are a few things to unpack here. A 10-year window is not really adequate to assess the buy-and-hold index strategy versus an active approach. Over this period, massive quantitative easing (QE) and a concurrent tech boom occurred, which caused cap-weighted indices like the S&P 500 to outperform significantly due to FANG stocks and more recently, Tesla. However, if we look back at the period from 1975 to 2002, there were times when US equities were flat in nominal terms and down in real terms, for example adjusting for CPI over this period the Dow Jones index (mutual fund perf would be worse) was only 87%, the Franklin Templeton Income fund (which is an income focused bond/equity mix) returned almost 250% in real terms. It is during these difficult markets that active strategies should perform better. No doubt there are other active strategies that underperformed in this period but just as an example over a longer time frame the comparison becomes much less clear.

The problem becomes more complicated because many active funds have different benchmarks, making it difficult to compare their performance. Additionally, the utility of a fund is another factor to consider. A fund that underperforms a passive approach might still be attractive to a client if it exhibits less day-to-day volatility and provides a smoother ride.

Furthermore, even a passive approach involves an active asset allocation step. For a private investor, they may not even realize they are making a strategic asset allocation when they choose the indices they want to invest in, but they are. Unfortunately, we do not have data on how much value this strategic asset allocation adds or subtracts.

One point of agreement I have is the need to be cautious with fees. High fees over time make it difficult for the end investor, as they will often sell at the bottom, fee's getting charged equally in good years and bad.

Also, it is important to consider that the experience of 2022 (and maybe the 1970-1990's) is perhaps the most relevant for the next 10 years, not the period from 2012 to 2022. With this in mind, it would be unwise to place all bets on a passive index tracker.