by Jake Moeller.
Since the days of the Delphic Oracle, it is in human nature to try to predict the future. I, for one, concede it is a difficult skill! At the end of 2017, I optimistically predicted that 2018 could be a good year for active funds. It has turned out to be a very testing one indeed—for mutual funds across the board and active funds in particular.
The thesis is that, typically, late-cycle environments precede a rotation out of momentum-biased ETFs and the increasingly expensive large-cap stocks in which they invest, providing fertile ground for active stock pickers.
However, quantitative easing and tightening has been distorting the market cycle considerably. Judging where we are in a “normal” market cycle is more art than science, but the complexity today is incalculable. The sudden shift in volatility which started in February 2018 hasn’t precipitated, as yet, a sustained structural shift in momentum.
Undoubtedly, 2018 was challenging. In local currencies, the Lipper Global Equity US classification returned -6.3%, Lipper Global Equity ex-US -14.1%, Lipper Global Equity Europe -13.0%, and Lipper Global Equity UK -11.0%.
Whilst 2017 was a record-breaking year for pan-European fund flows, with Lipper data showing €760 billion of estimated net inflows, 2018 was dire. Outflows of €129.2 billion represent the first after six consecutive years of net inflows.
Figure 1. Pan European Estimated Net Flows 2004 to 2018 (in € billion)
In terms of relative performance for 2018, passive vehicles secured a comprehensive victory over their active counterparts as the graphs below reveal.
Figure 2. UK Equity Funds Classification – Comparative Active & Passive Performance
Only 8% of active funds in the Lipper UK Equity classification beat the highest ranked broad-based tracker fund in the same classification in 2018.
Figure 3. Europe ex UK Equity Funds Classification – Comparative Active & Passive Performance
In the Lipper Europe ex-UK classification the figure was slightly higher, with 14% of active funds beating the highest ranked broad-based tracker fund in the same classification.
Figure 4. US Equity Funds Classification – Comparative Active & Passive Performance
In perhaps the most difficult classification to outperform—the Lipper US Equity classification—the performance of active funds was higher, with 24% of active funds beating the highest ranked broad-based tracker fund in the same classification.
It is dangerous to place too much importance on one-year data, but for each of the three- and five-year time periods, the data reveals that in aggregate for each of the three classifications above, investors would have been better off in a tracker fund.
When it comes to performance comparisons, it is important to consider the “opportunity cost” of not investing in an active fund (i.e., the potential outperformance of a fund over an index). Often this can be considerable.
The orange bars in each of the graphs show this. For example, in the five years to the end of 2018, the best-performing active fund in the Lipper UK Equities classification outperformed the highest ranking broad-based tracker by nearly 37 percentage points—a considerable outperformance for investors in that fund.
2018 was undoubtedly difficult for fund managers and investors alike. Further volatility, geopolitical uncertainty, and central bank influence will likely throw more curveballs for the market, but I remain an advocate of active funds.
We may soon enter a period which may be more conducive for active funds in aggregate but concede there is much room for improvement in 2019, and I will not be making any Oracle-like predictions this year.
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