Morningstar Compares Active vs. Passive Performance

Morningstar has launched an Active/Passive Barometer to help investors measure the performance of active U.S. fund managers against passive U.S. fund managers in every Morningstar category. The barometer will indicate success rates, which Morningstar defines as the percentage of actively managed funds that survive and generate higher returns than their passive counterparts in the same time period. Morningstar will also evaluate fund fees.

Key findings from the inaugural Morningstar Active/Passive Barometer, as of year-end 2014 data, include the fact that actively managed funds underperformed passive funds in nearly every asset class and Morningstar category, especially in the 10-year period. Low-cost active funds were more likely to survive, rather than being closed or merged into another fund, and to outperform higher-cost active funds, but their returns were lower than their passive counterparts in nine of the 12 Morningstar categories.

The U.S. mid-cap value category was the only one where actively managed funds had a 10-year success rate above 50%. In fact, low-cost active mid-cap value funds, which invest in both growth and value, had the highest success rate, at 68.2% for the 10-year period, while high-cost active mid-cap blend funds had the lowest success rate, at just under 5%.

Over the trailing three- and five-year periods, respectively, 72.9% and 69.7% of active intermediate-term bond funds beat their average passive peers. Actively managed U.S. value funds had higher long-term success rates than U.S. blend and growth funds; active large-cap value, mid-cap value and small-cap value funds had success rates of 38.2%, 54.4% and 48.4%, respectively, for the 10-year period.

Over the past 10 years, 40.2% of actively managed foreign large-cap blend funds survived and beat the average passive fund, nearly double the success rate of active U.S. large-cap blend funds.

The report also found that investors tend to select better-performing funds, as category asset-weighted returns were generally higher than the equal-weighted returns. For example, active U.S. large blend funds showed asset-weighted performance of 6.74% versus 6.42% equal-weighted performance over the trailing 10-year period.

“The active versus passive debate is a familiar one in the industry,” says Ben Johnson, Morningstar’s director of exchange-traded fund (ETF) research. “Our approach is squarely focused on the performance of actual investable options, instead of an index. We’re also replicating the investor experience by studying funds based on their category classification at the beginning of the time period, controlling for survivorship and taking into account the importance of fees.”

Morningstar will issue its Active/Passive Barometer twice a year. The full inaugural report can be seen here.