With pleasing regularity, experts at the fund analysis house Morningstar devote themselves to a diligent exercise: they determine the chances of an active fund earning a higher return than a comparable passive fund. As a reminder: whereas with active funds an expensive fund manager selects individual securities from the overall market, a passive fund simply invests in the overall market and charges only a fraction of the cost for doing so. Which type of investment is the better one? The latest Morningstar study, as one study among many others, provides the answer: in 2018, only 35% of active funds managed to outperform their passive counterparts (the figure applies to the US market; the barometer also exists for Europe, with similar results). In other words: if an investor bought an active fund, the probability of a losing outcome relative to pursuing a passive investment strategy was 65%. The race is decided even more clearly over longer periods: over the last 10 years, only 24% of active funds came out ahead. Over even longer periods, the figure keeps falling steadily. The headwind of costs that active fund managers have to push against is simply too strong.
The empirical figures, and not only those from Morningstar, are so unambiguous that you can safely consider the active-passive debate settled, comparable to the question of whether smoking harms your health. Interestingly, the general outperformance of passive funds, assuming precise measurement, even follows as a mathematical necessity. Because when an active fund manager wins relative to the overall market, this must necessarily come at the expense of another active investor. The reason: the winning stocks in the first fund manager's portfolio are missing from the second's. Passive investors, on the other hand, don't take part in this zero-sum game, because their portfolios contain all the stocks of the overall market. As a result, it's structurally impossible for them to perform noticeably worse than the overall market. If, in the next step, you take into account that active fund managers charge high fees for their zero-sum game and thereby considerably erode fund returns (yes, the losing funds charge high fees too; and no one knows in advance whether a fund will be among the winners or losers in the future), the Morningstar result is easy to understand. Incidentally, the Nobel laureate in economics William Sharpe already pointed out the structural and inevitable underperformance of active funds back in 1991.
Against this backdrop, it's also non-news when boerse.ARD reports that robo-advisors earned a higher return in 2018 than active funds. As much as we're pleased about this news: it isn't surprising.
But what the Morningstar figures also show: short-term return comparisons are useless. Anyone who puts an active and a passive fund into their portfolio for comparison purposes won't be able to draw reliable conclusions about the quality of the fund management after one or two years. Chance simply plays too large a role on the capital market. Only over many years can you assume that the passive fund will win the race.
So future active-passive studies will presumably no longer be worth a news report to us. It's good that they continue to be carried out, better safe than sorry. But there's no need to report on them.
The cited Active-Passive Barometer from Morningstar can be accessed here. You'll find the William Sharpe study mentioned here.
