Contrary to the popular belief that active strategies perform better in supposedly less efficient markets, such as the UK, 75% of large cap domestic UK active equity funds underperformed their benchmark over the last 10 years. Once factor exposure is taken into account, that figure rises to 95% of UK active funds underperforming their benchmarks.
- According to S&P, over the last 10 years, 75% of large cap UK active managers underperformed, 73% of mid cap, and 80% of small cap. This counters the ideas that actives have outperformed in the UK, and also that the ‘less efficient’ UK small cap space is better for active managers.
- Once factor exposure is considered, 95% of UK active funds underperform their benchmarks.
- The underperformance of actives has also been corroborated by research from ESMA, Vanguard, and Lyxor.
Section 1 of this post focuses on 2 sources of data: the Morningstar Active/Passive Barometer and the SPIVA reports. Both reports are updated every 6 months, and are cited widely in the industry as being the “scorecard” for assessing the performance of active funds. Both studies are conducted independently using their own separate data sets.
Section 2 contains a selection of other recent relevant studies that also contribute to the active/passive performance debate. Despite not being updated as regularly as the Morningstar and SPIVA reports, their conclusions are equally worth reading.
The Morningstar Active/Passive Barometer and the SPIVA reports
This section summarises the performance of active funds in the UK over the last 10 years, relative to their passive benchmarks. There is considerably more data in the underlying reports, which can be found here, and here. Both datasets cover the performance and survivorship of domestic UK large cap and mid cap funds. S&P Dow Jones also provides data for domestic UK small cap funds.
- Over the last 10 years, across both datasets, three quarters of large cap domestic UK active equity funds underperformed their benchmark.
- Over the last 10 years, according to S&P Dow Jones, 73% of UK large/mid cap equity funds underperformed their benchmark. According to Morningstar, only 25% of UK mid cap equity funds underperformed their benchmark.
- The difference lies in the number of UK mid cap funds taken as existing 10 years ago. S&P Dow Jones data shows 322 large/mid cap funds existing 10 years ago, yet Morningstar only show only 8. Given that 7 of the 8 funds in the Morningstar dataset have survived (88%), the survivorship/outperformance data is much higher for the smaller number of funds in the Morningstar data.
- Looking at small caps (S&P Dow Jones data only), over the last 10 years, approximately 80% of all UK small cap active funds underperformed their benchmark
- Across both datasets, less than 50% of large cap domestic UK active funds survived after 10 years.
- For mid cap funds, S&P Dow Jones data suggests 39% survived after 10 years, yet, as already seen, Morningstar data suggests 88% survival.
- According to S&P Dow Jones, 52% of UK small cap active funds survived after 10 years.
NB: S&P Dow Jones compares active funds’ performances against their S&P-assigned costless benchmark, based on the funds’ Lipper classifications. Morningstar compares active funds’ performances against a composite of actual passive funds – their “benchmark” reflects the actual, net-of-fees performance of passive funds.
NB: Survivorship is calculated by dividing the number of distinct funds that started and ended the period in question by the total number of funds that existed at the onset of the period in question (the beginning of the trailing one-, three-, five- and 10-year period)
Further evidence from other sources
Cass Business School
Researchers from Cass Business School in London studied the returns of domestic UK equity mutual funds to assess the performance of active fund managers. They sought to determine a) the extent of outperformance amongst UK active equity funds, and b) whether any excess returns from the outperforming funds is likely to be from luck or genuine skill.
“Taken together, the above results provide powerful evidence that the vast majority of fund managers in our dataset were not simply unlucky, they were genuinely unskilled. Although a small group of “star” fund managers appear to have sufficient skills to generate superior gross performance (in excess of operating and trading costs), they extract the whole of this superior performance for themselves via their fees, leaving nothing for investors.”
“Gross of fees, 95% of fund managers on the basis of the first bootstrap and all fund managers on the basis of the second bootstrap fail to outperform the luck distribution of gross returns”
ESMA – The EU’s securities regulator
Research conducted by the EU securities regulator, ESMA, in the first report of type, titled “Performance and costs of retail investment products in the EU” delved into the effect of fees on the performance of actively and passively managed European funds. Interestingly, the data suggests that European active funds have outperformed before fees are deducted, but underperform their passive counterparts after taking off their fees. Due to data limitations, the research excludes distribution costs, transaction costs, and performance fees, which would likely further increase the cost burden of active funds over passive funds.
“Costs are significantly higher for actively managed equity UCITS compared to passive UCITS. This leads to lower performance net of costs for active compared to passive equity UCITS.” [from the research paper]
“Retail fund investors lose up to a quarter of their gross returns in costs and charges” [from the FT summary]
ARC – Asset Risk Consultants
ARC are a popular investment consultant in the UK and Channel Islands, collecting performance data from discretionary investment managers and using the data to recommend investments for institutions and individuals. Their PCI report contains a snapshot of how the investment managers they monitor have performed relative to a blend of global equities and cash. Although the chart only covers the last 5 years, it tells an interesting story. The black dots represent the managers, whilst the line represents a portfolio containing only global equities and cash, in varying weights. The black dots below the line show that for an equivalent level of risk, an investor would have been better off investing in a blend of global equities and cash than with the investment manager. The black dots above the line show that the investment manager outperformed the global equity benchmark, adjusted for risk. The proportion of black dots below the line to those above the line show how poorly the managers have performed over the last 5 years.
Vanguard’s research paper, ‘The case for low cost index-fund investing’ shows on page 9 how between 60% and 90% of active funds underperformed their benchmarks over the last 15 years across all measured regions:
Lyxor’s research paper, ‘Analysing active & passive performance: What 2017 results tell us about portfolio construction’ shows on page 25 that between 11% and 50% of active equity funds outperformed their benchmark over the last 10 years – with 26% of active UK equity funds outperforming: