Do Active Equity Managers Outperform Passive Funds in a Bear Market?

Investors have been much more inclined to choose passive funds in recent years, with increasing awareness about the negative impact of high fees and publicly available figures on the long-term under-performance of active managers. However, a favoured opinion from proponents of active management is that active managers will outperform during a downturn.

While there are periods when the average active manager has a better chance of outperforming passive investment portfolios, there are two important factors to consider:

1) It is difficult to predict the managers who will outperform in any given year (a task similar to trying to time the market).

2) The persistence of outperformance year on year is incredibly low, especially once fund managers’ fees are taken into consideration (typically ranging between 0.6% and 1.0% a year).

What’s the evidence?

Our historic analysis (based on Morningstar data) has shown that actively managed funds have struggled to outperform passive strategies over time, once fees charged on both have been taken into account.1

We found that the median UK equity fund investing in large companies underperformed a tracker fund by 0.85% p.a. in the three years to December 2017 after costs. This was fairly typical when looking at rolling three year performance periods starting 15 years earlier in December 2002. The outcome varied over time, but on average the median fund gave up 0.3% p.a. to the tracker.

Moreover, performance persistence is poor. Evidence suggests that investors who selected UK funds which had ranked in the top 25% of funds over the preceding three years ended up with a fund that was in the bottom 25% of peers more often than one which stayed in the top 25% for the subsequent three years. This variation in active performance vs the predictability of passive performance has helped ETFs grow in popularity in recent years.

The tide has even washed over legendary stock picker Warren Buffett. In a diatribe against fee-hungry active Wall Street money managers in his 2017 annual letter to shareholders, he said: “Both large and small investors should stick with low cost index funds.”

Active management: worse than a coin toss

Extending analysis from a holding period of 3 years out to 10 years, which should allow more than enough time for fund manager skill to prevail, unfortunately less than 40% of UK equity fund managers were able to do so.

This experience is not unique to the UK. In the US, an index-tracking fund beat an astonishing 92% of all funds actively selecting stocks from a universe of large companies over the past 10 years. Even in Global Emerging Markets, which are said to be less efficient, and therefore rich hunting grounds for star stock-pickers – less than 35% of funds outperformed the index-tracking fund after their fees.

Falling markets

It’s a fact that markets go up and down in continuous cycles. During the great financial crash of 2007/2008, stock markets tumbled. They have risen again since March 2009, with some bumps along the way: the FTSE 100 has had 14 corrections of more than 5% in the period since the crash, one of which has been this year.

Active managers often claim that while passive strategies enjoy fruitful returns in bull markets, active managers will demonstrate their investment skill in downturns. Theoretically, this makes sense: active managers can carefully pick through stocks and avoid those with precarious valuations or excessive leverage, for example. But looking at the figures, where would investors do better in the event of a market downturn – with an active or passive manager?

Analysis performed by Netwealth on fund data from Morningstar shows that the figures don’t support the theory that active necessarily outperforms passive in a downturn.

What we learned, looking at the two major bear markets of the last 20 years:


  • During the financial crisis, less than half of UK active funds outperformed – between Jun 2007 and Mar 2009, 48% of active UK equity funds outperformed the tracker
  • It is very difficult to try and pick one of those 48% – if you picked from previous outperforming funds, it really had little impact on your chances of winning in the downturn.
  • It’s more about size than skill – UK fund managers tend to do better when small- and medium-sized companies are outperforming their larger counterparts. In the aftermath of the dotcom bubble at the turn of the century, the tracker fund was only able to beat 45% of managers between August 2000 and March 2003 when the market fell more than 40%, not least because the previously unloved FTSE Mid-250 Index beat the blue-chip FTSE 100 Index by a handsome margin.

Again, looking further afield:


  • Emerging Markets trackers beat 62% of the universe of active funds as the Dotcom Bubble burst, and 65% during the Global Financial Crisis.2
  • For the US, the equivalent numbers are 72% and 60% respectively.
  • In the additional bear market witnessed by Emerging Markets between December 2010 and September 2011, the index tracker again outperformed 65% of managers.

In summary, these findings reinforce our two main contentions: we continue to believe that the best active managers can add value, but (i) picking the managers who will outperform is notoriously difficult, and (ii) that consistency of fund outperformance after fees and costs is rare.

Do active funds really outperform passive funds in a downturn? The figures on average say no – and good luck sniffing out one that does.

Please remember that when investing your capital is at risk.

1 Source: For all quoted statistics, we have used Morningstar fund data with Netwealth analysis. For each fund, the cheapest available non-institutional share class has been used. Funds which were closed or merged during the period in question were included in the analysis, and relative performance to the point of closure considered.
2 We used a consistent time-frame for this analysis of different regions. Strictly speaking, the bear market in Emerging Markets during the Global Financial Crisis was from June 2007 to November 2008 in sterling terms. Over this period the outcome was much the same, with 57% of Emerging Markets managers under-performing the tracker.


Share this