Actively managed fund performance

What Is Actively Managed Fund Performance?

Actively managed fund performance refers to the returns generated by investment portfolios overseen by professional fund managers who aim to outperform a specific benchmark index rather than simply tracking it. This falls under the broader field of investment management and is a core component of portfolio theory, evaluating the success of a manager's active decisions. The objective of active management is to generate "alpha," which is the excess return above what a market-tracking strategy would achieve. Investors who choose actively managed funds pay fees in the expectation that the manager's skill in security selection, market timing, or strategic asset allocation will lead to superior returns.

History and Origin

The concept of actively managed fund performance dates back to the very origins of mutual funds, where professional managers were hired to make investment decisions on behalf of shareholders. For decades, active management was the dominant approach to investing. The belief was that skilled professionals could consistently identify undervalued securities or predict market movements to deliver returns exceeding the broader market.

However, the late 20th and early 21st centuries saw the rise of modern portfolio theory and efficient market hypothesis, which challenged the consistent ability of active managers to outperform. Pioneering research and the subsequent development of index funds and Exchange-Traded Funds (ETFs) by figures like John Bogle at Vanguard, led to a more critical examination of actively managed fund performance. Reports, such as the SPIVA (S&P Indices Versus Active) Scorecard from S&P Dow Jones Indices, began systematically comparing active funds against their passive benchmarks, often highlighting the consistent challenge active managers face in outperforming after fees. S&P Dow Jones Indices, for over 20 years, has measured actively managed funds against their index benchmarks worldwide, showing that the overwhelming majority of active managers globally have failed to outperform their respective benchmarks¹⁸, ¹⁹.

Key Takeaways

• Actively managed fund performance measures how well a fund manager's investment decisions generate returns compared to a passive benchmark.
• The primary goal of active management is to achieve "alpha," or excess returns beyond what the market offers.
• Studies by organizations like Morningstar and S&P Dow Jones Indices consistently analyze actively managed fund performance, often showing a majority underperform over longer periods.
• Higher fees and trading costs associated with active management can significantly erode potential returns, making outperformance more challenging.
• While difficult, some active funds do outperform, particularly in less efficient markets or specific market segments.

Interpreting Actively Managed Fund Performance

Interpreting actively managed fund performance requires looking beyond simple raw returns. A fund's performance should always be evaluated relative to its stated investment objectives and an appropriate benchmark. For instance, a large-cap equity fund should be compared to a large-cap equity index (like the S&P 500), not a small-cap or international index.

Key metrics for evaluating actively managed fund performance include:

• Alpha: The excess return of a fund relative to the return of its benchmark index. A positive alpha indicates outperformance.
• Tracking Error: Measures how closely a portfolio's returns follow the returns of its benchmark. Active funds typically have higher tracking error than passive funds because they deviate from the index.
• Sharpe Ratio: Measures risk-adjusted return, indicating how much return was generated for each unit of risk taken.
• Expense Ratio: The annual fee charged by the fund, expressed as a percentage of assets. Higher expense ratios make outperformance more difficult.

Regular reports, such as the Morningstar Active/Passive Barometer, provide insights into the success rates of active funds across various categories and time horizons¹⁶, ¹⁷. These reports often highlight that while some active funds outperform in the short term, consistent outperformance over longer periods (e.g., 10 years or more) is rare, especially in highly efficient markets like U.S. large-cap equities¹⁵.

Hypothetical Example

Consider two hypothetical mutual funds, Fund A (actively managed) and Fund B (passively managed), both aiming to invest in U.S. large-cap stocks over a 10-year period.

• Fund A (Active):
  • Initial Investment: $10,000
  • Average Annual Return (before fees): 8.5%
  • Annual Expense Ratio: 1.00%
  • Net Average Annual Return: 7.5%
• Fund B (Passive Index Fund):
  • Initial Investment: $10,000
  • Average Annual Return: 8.0% (tracking the S&P 500)
  • Annual Expense Ratio: 0.10%
  • Net Average Annual Return: 7.9%

In this example, the actively managed Fund A achieved a higher gross return (8.5% vs. 8.0%). However, after accounting for its significantly higher expense ratio, its net performance (7.5%) was lower than the passive Fund B (7.9%). Over 10 years, this seemingly small difference compounds:

• Fund A (Active) Final Value: $\text{$10,000} \times (1 + 0.075)^{10} \approx \text{$20,610}$
• Fund B (Passive) Final Value: $\text{$10,000} \times (1 + 0.079)^{10} \approx \text{$21,402}$

This hypothetical scenario illustrates how fees can impact actively managed fund performance, making it challenging for active funds to beat their passive counterparts even if their gross returns appear superior. This underscores the importance of considering net returns when evaluating fund choices, particularly in mutual funds.

Practical Applications

Actively managed fund performance is a critical consideration for individual investors, institutional investors, and financial advisors when constructing diversified portfolios. It is central to the debate between active and passive investing, influencing capital allocation decisions across the financial markets.

• Portfolio Construction: Investors determine whether to allocate capital to actively managed funds, passive funds, or a blend of both based on their investment strategy, risk tolerance, and belief in market efficiency.
• Fund Selection: Performance metrics, along with qualitative factors like manager experience and investment philosophy, are used to select specific actively managed funds.
• Due Diligence: Financial professionals and fiduciaries conduct rigorous due diligence on actively managed funds to ensure they align with client objectives and meet performance expectations after fees.
• Market Analysis: Industry reports, like Morningstar's Active/Passive Barometer and S&P Dow Jones Indices' SPIVA Scorecard, provide comprehensive data on the aggregate performance of actively managed funds across various asset classes and timeframes¹³, ¹⁴. These reports are widely cited in financial media and by researchers to understand broad market trends in active management. For instance, recent data indicates that in the U.S., actively managed mutual funds and ETFs fell short of their passive peers in 2024, with only about 42% of active strategies surviving and beating their average passive counterparts¹². This trend of underperformance is often noted, especially over longer time horizons¹⁰, ¹¹.

Limitations and Criticisms

Despite the appeal of potentially higher returns, actively managed fund performance faces significant limitations and criticisms:

• Underperformance Tendency: A major criticism, frequently highlighted by studies from Morningstar and S&P Dow Jones Indices, is that the majority of actively managed funds fail to outperform their respective passive benchmarks, especially over extended periods and after accounting for fees⁸, ⁹. For example, less than 22% of active funds survived and beat their average indexed peer over the decade through 2024 in the U.S.⁷. For U.S. large-cap equity funds, the underperformance rate can be even higher, with 65% of large-cap active funds underperforming the S&P 500 in 2024⁶.
• Higher Costs: Actively managed funds typically charge significantly higher management fees and incur greater trading costs than passively managed funds. These higher costs create a substantial hurdle that active managers must overcome before they can deliver any net outperformance to investors. Less than 5% of expensive active large-cap funds beat a composite of their passive peers over the decade through 2024, compared with 12% of cheaper active large-cap strategies⁵.
• Market Efficiency: In highly efficient markets, such as large-cap U.S. equities, information is quickly disseminated and reflected in prices, making it exceedingly difficult for active managers to consistently find mispriced securities or gain an informational edge⁴.
• Survivorship Bias: Performance studies sometimes exclude funds that have been liquidated or merged due to poor performance, potentially overstating the success rates of active funds.
• Inconsistent Alpha: Even active managers who demonstrate periods of outperformance often struggle to maintain that success consistently over many years. This makes selecting a future outperforming active manager a significant challenge for investors, as past actively managed fund performance is not indicative of future results. The active versus passive debate continues to be a central topic in the investment world, with some analysts noting that active managers have the potential to provide value in volatile or inefficient markets³. As of late 2023, the active-passive debate continues to rage as investors grapple with market volatility and seek to balance cost efficiency with potential upside.

Actively Managed Fund Performance vs. Passively Managed Fund Performance

The distinction between actively managed fund performance and passively managed fund performance lies at the core of a fundamental debate in investment strategy.

The confusion between the two often arises because both aim to provide returns from the market. However, active management seeks to beat the market, while passive management seeks to be the market. The consistent challenge faced by actively managed fund performance in outperforming benchmarks, particularly in efficient markets, has led to a significant shift in asset flows towards passive investment vehicles over the past decade².

FAQs

What does "actively managed fund performance" mean?

Actively managed fund performance refers to how well a fund run by a professional manager performs compared to a market benchmark, after the manager has made decisions about which securities to buy and sell. The goal is to "beat the market."

Why do many actively managed funds underperform?

Many actively managed funds underperform their benchmarks primarily due to higher fees and expenses, frequent trading costs, and the difficulty of consistently outsmarting efficient markets. Even if a manager picks some winning stocks, the costs can eat into any potential gains.

How can I evaluate an actively managed fund's performance?

To evaluate an actively managed fund's performance, look at its returns over various time periods (1, 3, 5, 10 years) compared to an appropriate benchmark index. Also, consider its expense ratio, its "alpha" (excess return over the benchmark), and its risk metrics like the Sharpe Ratio.

Is it ever worth investing in an actively managed fund?

While most actively managed funds struggle to consistently beat benchmarks after fees, some do succeed, particularly in less efficient market segments like small-cap stocks or specific international markets. Some investors may also choose active funds for specific investment strategies or for the expertise of a particular fund manager.

What is the SPIVA report?

The SPIVA (S&P Indices Versus Active) report is a semiannual publication by S&P Dow Jones Indices that systematically measures the performance of actively managed funds against their respective S&P Dow Jones benchmarks in various asset classes and countries. It is a widely cited source for data on actively managed fund performance¹.