394 / 772
8
Few investment topics are as hotly debated as the
merits of active and passive investing. The debate will
continue to ebb and flow with the regular cycles of
active managers’ collective out- or underperformance
relative to their benchmarks and a fast-growing
and rapidly evolving field of passive alternatives. In
order to ground this debate with data that reflect
investors’ shared experience, Morningstar is starting
to publish an Active/Passive Barometer. This is a
semiannual report that measures the performance of
U.S. active managers against their passive peers
within their respective Morningstar Categories.
The Active/Passive Barometer does not purport to
settle the active/passive debate. Rather, it offers
survivorship-bias-free data to inform this debate and
help investors better assess their odds of succeed-
ing with active managers across asset classes, time
periods, and fee levels. The report is available at
mfi.morningstar.com
.
This barometer is unique in the pragmatic way it
measures active-manager success. It compares active
managers’ returns against a composite made up
of relevant passive index funds (including exchange-
traded funds).We believe this is a superior approach
because it reflects the actual, net-of-fee performance
of passive funds rather than an index, which isn’t
investable. To replicate the opportunity set an investor
could have chosen from at the time, the Active/
Passive Barometer assesses active funds based on
their beginning-of-period category classification.
The report also tracks the asset-weighted and equal-
weighted average returns for active and passive
funds in each category, survivorship rates, and perform-
ance by fee quartile within each category.
In sum, the report should give investors a better
sense of how investors in active and passive funds
have actually fared across categories.
The Active/Passive Barometer finds that actively
managed funds have generally underperformed
their passive counterparts, especially over longer time
horizons, and experienced higher mortality rates
(that is, many are merged or closed). In addition, the
report finds that failure tends to be positively corre-
lated with fees. (Higher-cost funds were more likely to
underperform or be shuttered or merged away, and
lower-cost funds were likelier to survive and enjoyed
greater odds of success.) The data also suggest that
investors have tended to pick better-performing funds,
as the full category asset-weighted returns were
generally higher than the equal-weighted returns.
(This result does not hold within fee quartiles.)
The first table on the facing page shows active funds’
success rates by category. This is measured as the
percentage of funds from the beginning of the sample
period that went on to generate a return in excess of
the equal-weighted average passive fund return over
the period. To come up with a single return figure
for funds with multiple share classes, we calculate the
asset-weighted average return for each fund from its
underlying share classes. The last two columns show
the corresponding figures for the cheapest and most
expensive quartile of funds, respectively, within
each category.
There are a number of important patterns in the
data above:
p
Investors would have substantially improved their
odds of success by favoring inexpensive funds, as
evidenced by the higher success ratios of the lowest-
cost funds in all but one category.
p
On the flip side of the coin, investors choosing funds
from the highest-cost quartile of their respective cate-
gories reduced their chances of success in all cases.
p
The large-value category is the most poignant
example. The lowest-cost funds in this segment
had a success rate
28
percentage points higher than
the category average over the trailing
10
years
through December
2014
. Meanwhile, their high-cost
peers had a dismal success rate of just
19%
during
this same span.
A New Perspective on
Active Versus Passive
Morningstar Research
|
Ben Johnson