by Jake Moeller.
As I ran the data below for the end of 2019, it was with a certain sense of trepidation. I am on the record as being a vocal advocate of active funds and I knew that despite a rising tide in markets, many of them had struggled against their passive peers.
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, despite 2019 being a good year for equities markets generally, as well as a year that recouped the poor fund flows of 2018, active funds really haven’t shown any signs of being able to statistically beat their passive peers.
Figure 1. One-year percentage growth of Lipper global equity fund classifications to end of 2019 (GBP)
Active funds in the Lipper UK Equities classification have begun to show signs of improving performance relative to their passive peers after a sustained period of relative underperformance. Where there had been signs of similar improvement across the board to H1 2019, active funds in the US Equities and Europe ex UK Equities classifications have struggled towards the end of 2019.
At the end of 2018, only 14% of active funds in the Lipper UK Equity classification had beaten the highest ranked broad-based tracker fund in the same classification for the 12 months. This figure for 2019 has improved to 54%. Certainly, this is a material improvement, but only just better than the toss of a coin.
Over longer-term time periods, the numbers begin to drop off. For the three years to the end of 2019, only 35% of active funds in this classification beat the highest-ranked passive peer, and over five years, this figure falls to a disappointing 29%.
Figure 2. UK equity funds performance
Active funds in the Lipper Europe ex-UK equity classification have not fared as well although the 2019 figure has improved. At the end of 2018, only 13% of active funds in the Lipper European Equity classification had beaten the highest ranked broad-based tracker fund in the same classification for the 12 months. For 2019, this figure has improved to 28%.
Over longer-term periods, the numbers remain reasonably constant (and low). For the three years to the end of 2019, only 23% of active funds in this classification beat the highest-ranked peer and for five years, this figure is 24%.
Figure 3. Europe ex-UK equity funds performance
We are all familiar with the theory of the efficiency of the US market and the difficulty active funds have in beating it. The numbers for active funds in 2019 make grim reading here. At the end of 2018, 26% of active funds in the Lipper US equity classification had beaten the highest ranked broad-based tracker fund in the same classification for the 12 months. In 2019 this number has retreated to 17%.
The longer-term figures are also very disappointing. For the three years to the end of 2019, only 26% of active funds beat the highest-ranked passive peer over the same period. For five years, this figure is a paltry 17%.
Figure 4. US equity funds performance
The “opportunity cost” of not investing in an active fund (i.e., missing out on alpha) can still be material, especially over longer periods of time. In this limited study, over 2019, there has been some convergence in the European and US equities classifications, but some divergence in UK equities.
The blue bars in each of the graphs on the right-hand side reveal this. At the one-year ended 2019, the best-performing active fund in the Lipper UK Equities classification outperformed the highest-ranking broad-based tracker by a mighty 21.1 percentage points.
In the Europe ex-UK classification, over the same yearly period, that figure is 12 percentage points and for US equities, 11 percentage points. All these figures become larger over the three- and five-year time periods.
It may be tempting to conclude on the back of this data that an investor is better off simply investing in an index tracking fund, certainly for the European ex UK and US equities markets.
We know, however, that investors don’t (or at least shouldn’t) select funds at random. Those investors who have selected funds which are producing those high levels of alpha will be much better off than the tracker fund investors.
I cannot dispute these data points and, whilst like many active fund advocates, I have long held belief that we may be entering a period in the market cycle which is more conducive for active funds in aggregate. I recognise that at the moment however, this is a hard sell.
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