A view on the market movements between April 1, 2023, and March 31, 2024, shows that it is fair to say that this period was a period in which active fund managers could have shown their asset selection and timing skills since the markets were driven by a number of different factors. Each of these factors could have caused a major market downturn on their own. There were a lot of geopolitical tensions around the globe beside the war in Ukraine, which showed that democratic states are more vulnerable than one may think.
Also, there were economic factors which burdened the expectations of investors, such as China’s failure to meet the growth expectations of investors when its economy was reopened after the end of the country’s zero-COVID strategy in 2023. Talking about China, the credit crisis in the Chinese real estate sector later in the year was another factor that could have caused a market downturn if it wasn’t handled well by the Chinese government. Nevertheless, investors are still cautious about investments in China.
After the meltdown in the bond segment during the interest hiking cycle over the course of 2022, investors hoped that the measures taken by central banks would bring down inflation and lead to falling interest rates. This assumption went against the hawkish statements of central banks around the globe for the first 10 months of 2023. The relatively high interest rates raised fears that some major economies such as the U.S. would face a hard landing. That said, the assumed probabilities for such a scenario in the U.S. were not high and are going further down since the U.S. Federal Reserve lowered the interest rates by 50 basis points in September as the inflation in the U.S. has come down to a level which seems to be comfortable for the policymakers, while the U.S. economy seemed to be quite strong.
The move of the U.S. Fed followed the moves of other major central banks like the European Central Bank (ECB) which kept its promise and lowered the interest rates in its May meeting, which might have been a relief for investors in Europe since some economies in the Eurozone are struggling with high interest rates. Nevertheless, the ECB made quite clear that there is currently not much room for further decreasing rates.
Opposite to the central banks in the western countries, the Bank of Japan (BoJ) increased the interest rates in Japan despite a clear communication of the BoJ to an increased market volatility around the globe, as some speculators had to close their carry trades.
In addition, the spectacular performance of the so-called Magnificent Seven (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla) drove the U.S. markets up. The stellar performance of these stocks might have reminded some investors of the performance of some stocks before the burst of the so-called “dot.com bubble.” That said, some of these stocks have fallen significantly over the first nine month of 2024 without causing a domino effect for other companies. As a result, many investors might have been caught between fear and greed when looking at these stocks or the U.S. equity markets as a whole.
Therefore, it was somewhat surprising that some major equity indices reached several new all-time-high values over the last 12 months despite all the economic and geopolitical headwinds over the course of the evaluation period.
With these facts in mind, the last 12 months can be seen as a time period in which active asset managers had the chance to deliver a high value-added compared to passive strategies by using cash as a risk buffer in times of market turmoil and investing in high beta stocks in an upswing of the market. In general, the results of this study show that the average actively managed equity fund did not achieve this goal.
Since this study was conducted over a limited time period, the results have only a limited prediction power for the long-term results of active managers. Nevertheless, studies over different time periods have shown similar patterns.
A Test of Market Efficiency
Since the assets under management in passive equity products have surpassed the assets under management in actively managed products in Q2 2023, some market observers and watch dogs are concerned that this may impact the efficiency of the markets.
According to the Efficient Markets Hypothesis (EMH) by Eugene F. Fama, one sign for a declining market efficiency would be an disproportional high percentage of active fund managers outperforming the market, hence their fund manager benchmark.
With regard to this, one could see the results from this study also as a test if the markets are still efficient, despite the fact that there is more money invested in passive than in actively managed products.
Graph 1: Overall Assets Under Management in Equity Products Globally by Management Approach (in bn EUR)
Source: LSEG Lipper
Nevertheless, since the growth rate for passive products tends to be higher than for actively managed products, the market share for passive products will further increase. As nobody currently knows at what point markets start to become inefficient, regular reviews such as this market study are needed to identify trends which are a hint for, or are caused by, market inefficiencies.
Methodology
The analyzed fund universe has been derived from all mutual funds and ETFs listed in the Lipper database, with the asset type equity assigned. From this universe we excluded all passive products, as well as all convenience share classes, and all leveraged products. We also excluded all funds which have been liquidated or merged during the year, as there is no complete performance history for these products for the analyzed time period. As a result of the last step, this analysis has a survivorship bias, which is in favor of the average results; i.e. the stated average results might be more positive as they would be if all merged and liquidated funds would have been taken into consideration.
Passive funds were excluded from this comparison, as the aim of the analysis is to show whether actively managed funds in general, and ESG-related products in particular, were able to add value over the course of the analyzed time period. In this regard, the inclusion of passive products would have skewed the results since the expected return of a passive product is the return of the index minus the total expense ratio of the respective product.
ESG-related products were chosen based on the assignment or mentioning of ESG credentials in the fund prospectus or other fund-related documents. With regard to this, it is clear that this approach overstates the number of “real” ESG funds since the naming of a fund or the assignment of ESG credentials do not automatically lead to an investment approach which is considered as sustainable investing. That said, the new regulations introduced by market watchdogs around the globe with regard to the usage of ESG-related terms in the fund names or fund documents will help to narrow this broad group of funds over time. Therefore, one needs to bear in mind that the results for ESG-related products might be impacted in one way or another by funds which may not follow a sustainable investment approach at all.
We used the fund manager benchmark and in a second analysis the technical indicator as reference to calculate the relative performance of the respective actively managed funds between October 1, 2023, and September 30, 2024. A closer look at the number of funds in each analysis shows that it is worth conducting a second analysis, as a large number of funds do not disclose their benchmarks or use a benchmark that is not available in the Lipper database. Since the analysis includes funds from all parts of the world, the base currency for all calculations is the U.S. dollar.
Since not all funds have or disclose a benchmark, Lipper has assigned standard market benchmarks as technical indicators for all Lipper Global Classifications which allow relative calculations to be performed even when the fund manager benchmark is missing. One example of this is the Lipper Global Classification (LGC) Equity Global, where we assigned the MSCI Global TR USD as technical indicator for all funds with a plain vanilla global equity investment objective. Funds with a more specific investment objective will receive an individual technical indicator, which is more suitable than the generally assigned plain vanilla index. Although a technical indicator is quite helpful for the analysis of a complete peer group—it has some flaws—as the respective benchmark may not represent all restrictions applied at the fund level. This is especially true with regard to ESG/SRI funds since a standard market benchmark does not take any ESG/SRI criteria into consideration and may have, therefore, a deviant asset allocation at country and sector level compared to the respective fund.
Results: Relative Performance of Actively Managed Funds Versus Their Fund Manager Benchmarks
A look at the overall results of the relative performance of the 13,959 actively managed funds (conventional and ESG-related) versus their fund manager benchmarks shows that active managers failed to deliver added value since 4,170 funds (29.87%) delivered an outperformance, while 9,789 funds (70.13%) were underperforming their respective fund manager benchmarks over the course of the analyzed 12-month period. These numbers show that the percentage of outperforming funds has slightly decreased compared to the report as of June 30, 2024. The overall average relative performance of all equity funds compared to their fund manager benchmarks for the analyzed 12-month period is negative 3.29%, which is slightly better than in our last report (-3.99%).
This underperformance needs to be seen in the light of the fees and expenses paid by the fund since indices and benchmarks do not include any fees and expenses. The overall TER for all equity funds covered within this study is 1.477%, which means that roughly 45% of the average underperformance of the funds compared to the fund manager benchmarks can be attributed to fees and expenses.
Graph 2: Percentage of Outperforming and Underperforming Funds (Relative Performance vs Fund Manager Benchmark) between October 1, 2023, and September 30, 2024
Source: LSEG Lipper
One reason for the low percentage of outperforming ESG-related funds can be seen in the fact that a number of ESG-related funds are using conventional benchmarks to showcase their ability to beat the respective market. This approach has often been taken as critics raised concerns about a possible underperformance of ESG-related products compared to their conventional peers caused by their exclusion criteria. As for this, a performance comparison against a broad conventional market benchmark seems to make sense to calm down the critics, but it also contains the risk of wrong assumptions in market environments which favor companies/sectors/industries which are not eligible for or out of scope of ESG-related funds.
With regard to the above, it can be concluded that the equity markets seem quite efficient since there is no sign of a disproportionately high number of actively managed funds outperforming their fund manager benchmarks. Rather the opposite is the case—the number of outperforming funds has declined in the current report compared to the report as of March 31, and June 30, 2024.
In more detail, 2,779 (31.19%) conventional funds beat their respective fund manager benchmarks, while 6,132 (68.81%) showed an underperformance over the course of the analyzed time period. The disadvantage of actively managed products gets even clearer in the segment of ESG-related funds, where only 27.56% (1,391) of the available products showed an outperformance, while 72.44% (3,657) of funds showed an underperformance compared to their respective fund manager benchmarks. It is noteworthy, that the average results for ESG-related funds are slightly better than in the previous report.
Graph 3: Percentage of Outperforming and Underperforming Funds (Relative Performance vs Fund Manager Benchmarks) between October 1, 2023, and September 30, 2024, by Management Approach
Source: LSEG Lipper
To evaluate the success of actively managed funds, it is not enough to count the funds which have outperformed or underperformed their respective fund manager benchmarks. It is also important to analyze the respective margin. The overall average performance of conventional funds between October 1, 2023, and September 30, 2024, was negative 3.29%, while ESG-related showed an on average lower overall underperformance of negative 3.25%. A closer look at the performance pattern shows that outperforming ESG-related funds showed a slightly lower average outperformance (4.82%) compared to their conventional peers (4.86%). Opposite to this, ESG-related funds (-6.33%) showed a lower average underperformance compared to their conventional peers (-7.01%).
Graph 4: Average Outperformance and Underperformance of Active Managed Funds (Relative Performance vs Fund Manager Benchmark) between October 1, 2023, and September 30, 2024, by Management Approach
Source: LSEG Lipper
These results may indicate that the market environment over the analyzed time period was in favor of conventional funds since companies from some of the so-called old economy sectors showed good returns alongside some of the “Magnificent Seven.” That said, companies from the old economy sectors are often not as advanced with regard to their ESG credentials and, therefore, are often excluded from ESG-related portfolios. In addition, it is noteworthy that the currently higher interest rates do have a negative impact on some companies in sectors such as clean energy, etc., as the higher interest rates made it more expensive for those companies to grow their business. Hence, they may look less attractive for investors from a growth perspective. Keeping in mind that a high number of ESG-related funds are using conventional fund manager benchmarks, it can be concluded that the overall success of ESG-related funds compared to their conventional peers is highly dependent on market trends.
Results: Relative Performance of Actively Managed Funds Versus Their Technical Indicators
The usage of the technical indicator led to a larger universe of funds for this analysis. But even as the fund universe grew by around 10,000 products to 23,382 funds and ETFs, we witnessed somewhat the same results for the relative performance of actively managed equity funds versus their technical indicators. This is because 6,925 products (29.62%) were able to outperform their technical indicators. Meanwhile, 16,457 products (70.38%) showed an underperformance. These results are echoing the trend visible in the relative performance vs. the fund manager benchmarks since the results are also slightly worse than those from the previous report. The overall average relative performance of all equity funds compared to their technical indicators for the analyzed time period is negative 4.06%. This average underperformance is slightly higher than in the previous report (-3.99%).
As mentioned before, this underperformance also needs to be seen in light of the fees and expenses paid by the fund since indices and benchmarks do not include any fees and expenses. The overall TER for all equity funds covered within this study is 1.547%, which means that roughly 38% of the average underperformance compared to the technical indicators of the funds can be attributed to fees and expenses.
Graph 5: Percentage of Outperforming and Underperforming Funds (Relative Performance vs Technical Indicator) between October 1, 2023, and September 30, 2024
Source: LSEG Lipper
These results underpin the statement that the equity markets around the globe seem quite efficient since the majority of active fund managers were not able to beat the technical indicators which Lipper has assigned to their funds.
A closer look at the details shows that the underlying pattern of the ratio between outperforming and underperforming funds relative to their technical indicators is somewhat in line with results when comparing the funds with their fund manager benchmarks. The majority of conventional funds (10,766, or 69.44%) showed an underperformance compared to their respective technical indicator, while 4,738, or 30.56%, showed an outperformance. These numbers echoed the slight decrease in the overall numbers shown in the results of the funds versus their respective fund manager benchmarks. Conversely, the results for ESG-related products were slightly better compared to the former report, as 72.24% (5,691) of the ESG-related products showed an underperformance, while 27.76% (2,187) showed an outperformance.
Graph 6: Percentage of Outperforming and Underperforming Funds (Relative Performance vs Technical Indicator) between October 1, 2023, and September 30, 2024, by Management Approach
Source: LSEG Lipper
As far as the relative performance versus the technical indicator is concerned, one also needs to evaluate the level of outperformance and underperformance to evaluate the success of the respective funds versus their technical indicators. In general, it can be said that the gap between the average out- and underperformance has widened as the universe of analyzed funds has increased. This increase might be caused by the fact that the technical indicator is not always a suitable benchmark for performance comparisons, as it may not fully represent the eligible investment universe of specific funds, especially when they are following an ESG-related investment approach.
The overall average relative performance of conventional funds compared to their technical indicators between October 1, 2023, and September 31, 2024, was negative 3.80%, while ESG-related funds showed on average a higher overall underperformance of negative 3.60%. A more detailed view of the performance pattern shows that ESG-related funds showed on average a lower relative underperformance (-7.62%) compared to their conventional peers (-8.64%). Conversely, ESG-related products showed an on average lower outperformance (+6.01%) than their conventional peers (+6.32%).
Graph 7: Average Outperformance and Underperformance of Actively Managed Funds (Relative Performance vs Technical Indicator) between October 1, 2023, and September 30, 2024, by Management Approach
Source: LSEG Lipper
Since the relative performance of actively managed funds versus their technical indicators were somewhat in line with the results shown relative to their fund manager benchmarks, it can be concluded that actively managed funds were on average not able to deliver value-added for investors over the course of the analyzed time period.
It should be noted that while the use of a technical indicator is a valid comparison to evaluate the performance of a fund compared to the broad market, it has only limited explanatory power with regard to the relative performance achieved with the individual investment objective of a fund, as the fund may have different constraints on selection of single securities which are not reflected in the technical indicator. This might be especially true for ESG-related products.
From my perspective, the Achilles heel of the asset management industry is the way the risk management process works. Most asset managers measure the risk of their portfolios relative to their benchmark or index. As a consequence, the asset allocation decisions of portfolio managers are restricted by the weighting of the stock, sector, region, or country within the respective benchmark. This means that a portfolio manager might not be able to avoid an investment in a stock or sector which he/she expect to underperform.
In addition, a high number of asset managers evaluate the performance of the fund relative to its benchmark, resulting in the fact that a negative performance of the fund is seen as a success as long as the negative returns are better than those of the respective index or benchmark. Conversely, most investors see negative returns in general as bad results. Therefore, it would make sense that asset managers would implement some risk measures with regard to the absolute performance of their funds to align the interest of investors with the targets of the portfolio managers. Taking the absolute performance into consideration would also help to increase the resilience of a fund to market events since the portfolio manager could use cash as a risk buffer. I certainly know that this is a much-debated topic and that there are different views on this topic in the investment industry. Therefore, I will leave this topic for another discussion.
This article is for information purposes only and does not constitute any investment advice.
The views expressed are the views of the author, not necessarily those of LSEG Lipper or LSEG.
