Should the spurious claims by supporters of the active fund management industry be finally laid to rest?

Investors have been much more inclined to choose passive funds in recent years – driven by increasing awareness about the negative impact of high fees and publicly available figures on the long-term underperformance of active managers. Yet a favoured opinion from proponents of active management persists: that active managers will outperform during a downturn.

New evidence is emerging that – again – this is not the case.

The current coronavirus-fuelled disruption in markets has created the kind of conditions where active managers should, in theory, thrive. However, our analysis of Morningstar data for the turbulent first quarter of 2020 show that active managers have failed to outperform in regions across the world.

The UK has proved to be particularly challenging: with an active peer group underperforming a leading FTSE All-share ETF by 3.5% over the period. This is probably due to their enduring preference for smaller companies which markedly underperformed larger ones.

These findings are reinforced by articles this week in the Financial Times and The Telegraph, which show how difficult outperformance is to achieve.

• The FT reported – citing analysis of 1,350 funds by Copley Fund Research – that US equity funds underperformed equivalent passive funds by 1.44%, net of fees, in the first quarter of 2020, the worst showing in four years. The FT also reported that UK, EM and Japan funds also fell short in the period.


• The Telegraph stated that fewer than half (43%) of the funds run by managers have beaten the FTSE All-Share index so far in 2020 – with a similar outcome in Europe – while just 22% of active funds investing in emerging economies have beaten the MSCI Emerging Markets index since the start of the year.

None of this is surprising. It is furiously difficult to outperform the market consistently or for any given period of time. The latest findings also concur with our research into the previous two downturns.

What we learned from before

Markets go up and down in continuous cycles. During the great financial crash of 2007/2008, stock markets tumbled. They rose again after March 2009, with some bumps and rebounds along the way, before the severe disruption we are now enduring because of the coronavirus.

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.

So we examined the figures to see where would investors do better in the event of a market downturn – with an active or passive manager? And our analysis 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 last 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.¹


• 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 maybe it’s time to put that contention to rest.

Please remember that when investing your capital is at risk.

¹ For all quoted statistics, we have used Morningstar fund data with Netwealth analysis. 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..