After an exceptional bull market that lasted more than a decade, volatility and higher interest rates set the stage for the return of active management and stock-picking investors were ready for the spotlight.
Out of 8,212 funds with approximately $17 trillion in assets (about 55.9 percent of the U.S. fund market), 57 percent of actively managed mutual funds and ETFs survived and beat their average passive counterpart over the 12 months through June, according to Morningstar’s semiannual Active/Passive Barometer report. That was many more actively managed funds than the 2022 calendar year, when only 43 percent were successful.
Morningstar’s barometer evaluates active funds against a composite of passive funds so the benchmark reflects the actual, net-of-fees performance of investable passive funds. It also considers how the average dollar invested in active funds fared versus the average dollar invested in passive.
Small-cap managers did especially well; more than 65 percent beat their average passive peer. That wasn’t surprising to Morningstar. Small-cap managers have generally had higher success rates than equity managers focused on other company sizes, partly because the stocks are less liquid and more efficiently priced, according to the research firm. “Their 27.9 percent success rate there over the past 15 years is highest among all U.S. stock categories, and the long right tail in their excess returns distribution indicates that success can sometimes mean winning big,” the report said.
Fifty-six percent of active mid-cap and 53 percent of large-cap managers beat their average passive peer.
As a group, bond managers had the best performance turnaround. More than 55 percent of active bond managers survived and beat the passive average, something only 30 percent of them managed to accomplish in 2022. All three active fixed-income categories tracked by Morningstar boosted their success rates by at least 15 percentage points. Active corporate-bond managers did the best of the three, with a 60 percent success rate, up from 34 percent in 2022. (Credit hedge funds are also in demand and performing well.)
Active real estate strategies tracked by Morningstar returned to a success level more in line with their historical long-term results; 67 percent percent beat their benchmark, doubling the percentage that did in 2022.
The fees investors pay active managers are not a proxy for which ones are doing best. The cheapest active funds succeeded more often than the priciest ones. Over the previous 10 years, 31 percent of active funds in the cheapest quintile beat their average passive peer, compared with 19 percent for those in the priciest quintile.
Over the past 10 years, the average dollar invested in active funds outperformed the average active fund in 19 of the 20 categories, which means investors favored cheaper, higher-quality strategies and “have chosen active funds wisely,” according to Morningstar.
But active managers should pause before taking a victory lap. The improved performance by actively managed funds “did little to change their long-term track record against their passive peers,” the Morningstar report says.
Only one out of every four active strategies survived and beat their average passive counterpart over the 10 years through June 2023. Foreign-stock, real estate, and bond funds had the best long-term success and U.S. large-cap strategies had the lowest.
The distribution of 10-year excess returns versus passive peers varies widely across categories.
“In the case of U.S. large-cap funds, it skews negative, indicating that the likelihood and performance penalty for picking an underperforming manager tends to be greater than the probability and reward for finding a winner,” according to the Morningstar report. “The inverse tends to be true of the fixed-income and certain foreign-stock categories we examined, where excess returns among surviving active managers skewed positive over the past decade.”
