The script flipped from value to growth in 2023, but the narrative stayed the same for active managers.
Of the nearly 3,000 active funds included in our analysis, 47% survived and outperformed their average passive peer in 2023.
We further analyze these findings in the year-end 2023 installment of the Morningstar Active/Passive Barometer, a semiannual report that measures the performance of US active funds against passive peers in their respective Morningstar Categories. The Active/Passive Barometer spans over 8,300 unique funds that accounted for approximately $18 trillion in assets, or about 55% of the US fund market, at the end of 2023.
You can learn more about the background of our approach to the report in this article.
Most Active Managers Failed to Capitalize in 2023
When viewed as a whole, active funds had less than a coin flip’s chance of surviving and outperforming their average passive peer in 2023, although results varied widely across asset classes and categories.
Foreign and fixed-income active funds bounced back in 2023, but were weighed down by US stock-pickers’ declining performance. That group notched a success rate of 46% in 2023, versus success rates above 50% for foreign and fixed-income managers in aggregate.
Active bond funds struggled during the risk-off market in 2022, but they staged a significant comeback last year. Each fixed-income category included in our report saw its success rate increase by 19 percentage points or more in 2023. This trend aligns with active managers’ willingness to take on more credit risk than market-value-weighted passive peers. Tightening credit spreads worked in active managers’ favor last year while widening spreads hurt in 2022.
Year-Over-Year Change in Active Funds' One-Year Success Rate by Category (%)
But one year isn’t a sufficient time horizon from which to draw conclusions. Success rates can fluctuate wildly from year to year, depending on what’s going on in the markets and how that reflects on the actively managed portfolios as well as in the passive funds we measure them against.
Longer horizons provide stronger signals that investors can incorporate in their selection process. In general, actively managed funds have failed to survive and beat their benchmarks, especially over longer time horizons. Less than one out of every four active funds topped the average of their passive rivals over the 10-year period ended December 2023.
But success rates vary across categories. Long-term success rates were generally higher among the bond, real estate, and US small-cap categories, where active management may hold the upper hand. Investors can use this data to identify areas of the market where they have better odds of picking winning active funds.
Active Funds' Success Rate by Category (%)
Sizing Relative Performance of Passive and Active Investing
Success rates alone only tell half the story. The other half is the prospective payoff for choosing a winning fund and the penalty for picking a loser. The Active/Passive Barometer contains this information in the form of plots of the distribution of 10-year excess returns for surviving active funds versus the average of their passive peers.
Much like success rates, these distributions vary widely across categories. In the case of US large-cap funds, the distributions skew negative. This paints a bleak picture for active funds in these categories. They have low long-term success rates, while penalties can be high for picking a loser (per the negatively skewed distribution).
The opposite tends to be true of fixed-income, real estate, and certain foreign-stock categories, where long-term success rates have generally been higher and excess returns among surviving active managers skewed positive over the past decade. The exhibits below show the distributions of excess returns for surviving active funds from the large-blend and intermediate-core bond categories.
Distribution of 10-Year Annualized Excess Return for Surviving Active Large-Blend Funds
Distribution of 10-Year Annualized Excess Returns for Surviving Active Intermediate Core Bond Funds
Costs Matter for Both Passive and Active Strategies
The signal that rings loud and clear in this dataset is that fees matter. Funds in the cheapest quintile succeeded more often than funds in the priciest one (29% success rate versus 18%) over the 10-year period through 2023.
Investors have caught on. Over the past 10 years, the average dollar invested in active funds (asset-weighted average return) outperformed the average active fund (equal-weighted average return) in 19 of the 20 categories examined, as seen in the first three columns of the below table. That implies investors favor cheaper, higher-quality strategies.
Comparison of Asset- and Equal-Weighted 10-Year Returns %
The author or authors do not own shares in any securities mentioned in this article.Find out about Morningstar’s editorial policies.
In general, actively managed funds have failed to survive and beat their benchmarks, especially over longer time horizons. Less than one out of every four active funds topped the average of their passive rivals over the 10-year period ended December 2023. But success rates vary across categories.
While passive funds still dominate overall due to lower fees, some investors are willing to put up with the higher fees in exchange for the expertise of an active manager to help guide them amid all the volatility or wild market price fluctuations.
Active managers held a 57% success rate, up from 38% in 2022. Mortality and distribution of 10-year annualized excess returns for surviving active intermediate-core bonds. Although just half of funds survived the full period, 63% of the ones that did succeeded.
More than a third of active equity managers outperformed passive counterparts over the last one-year period. Active bond managers did even better, with 62.7% on average outperforming their passive alternative.
There's little doubt that passive investing is growing quickly and taking market share from active funds. Last month, for the first time, passively-managed funds in the US controlled more assets than did their actively managed competitors.
“BlackRock, Vanguard, and State Street are often lumped together for the purpose of considering large passive managers within the U.S.,” Stewart told Institutional Investor.
Another driver of the underperformance of active funds, according to McDermott, is fees: “All funds have years where they underperform, however, the longer-term evidence is undeniable that active managers have continued to struggle. The main reason for this underperformance is because active funds charge higher fees.”
Although it is very difficult, the market can be beaten. Every year, some managers boast better numbers than the market indices. A small fraction even manages to do so over a longer period. Over the horizon of the last 20 years, less than 10% of U.S. actively managed funds have beaten the market.
Actively managed investments charge larger fees to pay for the extensive research and analysis required to beat index returns. But although many managers succeed in this goal each year, few are able to beat the markets consistently, Wharton faculty members say.
Because active investing is generally more expensive (you need to pay research analysts and portfolio managers, as well as additional costs due to more frequent trading), many active managers fail to beat the index after accounting for expenses—consequently, passive investing has often outperformed active because of ...
Active funds strive for higher returns and come with higher costs and risks. Passive funds offer steady, long-term returns at lower costs but carry market-level risks. Explore key differences between active and passive funds in this blog.
Only one out of every four active funds topped the average of their passive rivals over the 10-year period ended December 2022. But success rates vary across categories. Long-term success rates were generally higher among bond, real estate, and foreign-stock funds, where active management may hold the upper hand.
These include undesirable concentrations of stocks, systemic risk and buying at too high valuations. Investing passively should not be seen as a low governance 'set-and-forget' option. While it is no panacea, active management can overcome some of these issues.
Passive investment products have long been pulling in the lion's share of money from investors, but as 2023 came to a close they achieved a milestone: holding more assets than their actively managed counterparts.
The empirical research demonstrates that higher passive ownership decreases market liquidity (higher bid-offer spreads), decreases the informativeness of stock prices by increasing the importance of nonfundamental return noise, reduces the contribution of firm-specific information, increases the exposure to stocks of ...
Active equity funds rely on managers' decisions, while passive funds attempt to track indices efficiently. As per SPIVA, five out of 10 large-cap funds underperformed the S&P BSE 100, while over 73% of mid- and smallcap schemes lagged the S&P BSE 400 MidSmallCap in 2023.
Introduction: My name is The Hon. Margery Christiansen, I am a bright, adorable, precious, inexpensive, gorgeous, comfortable, happy person who loves writing and wants to share my knowledge and understanding with you.
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