Reporters often prepare obituaries in advance for ailing celebrities so that when the end comes, they can publish instantaneously. Occasionally, someone hits “publish” prematurely, posting tributes for public figures who are very much alive.
In the same way, much ink has been hastily spilled recently in obituaries for active management. Most of the negativity has focused on the rise of passive investing, which has enjoyed strong performance during the past few years. But simply because one style of investing has come into favor does not mean others are going the way of the dodo.
So why are so many pundits ready to write off active management? And what makes us so sure that investing actively is not only a viable but essential part of investor portfolios?
What Have You Done For Me Lately?
Recency bias is the tendency to believe that recently observed patterns will continue into the future, and it’s a powerful force that can influence investor decisions. But investors who only take recent performance into account are missing the forest for the trees. After all, yesterday’s events shouldn’t determine how tomorrow’s investment decisions are made.
Morningstar Large Blend is the largest Morningstar category with $6.37 trillion in net assets, and it constitutes 23% of the US mutual fund market.1 We selected this category because it’s widely believed to be the most efficient—the one in which active investing supposedly makes the least sense.
To represent active management, we removed all index funds and enhanced index funds. To represent passive management, we used the Morningstar S&P 500 Tracking category.
As shown in FIGURE 1, passive large-blend strategies have outperformed active large-blend strategies for the last eight years, which helps to explain why in 2021 passive US equity funds had inflows of $346 billion, while more than $195 billion under active management headed for the exits.1
But the past seven years only tell part of the story. A wider look at the chart reveals active and passive have traded the lead in performance over time like two evenly matched racehorses. From 2000 to 2009, active outperformed passive nine out of 10 times. During the 1990s, passive outperformed active six out of 10 times. And over the course of the past 35 years, active outperformed 14 times while passive outperformed 19 times (they tied in 2010).
We’ve seen that the cyclical nature of active vs. passive investing definitely applies to the Morningstar Large Blend Category. The same holds true for other investment categories such as mid-caps, small-caps, and global/international equities. And just like performance, investor sentiment moves in cycles. If a certain style or asset class is doing well, investors are quick to extol its virtues and pour their money into it. It’s no surprise, then, that passive investing is the new darling of many investors and much of the financial press. But just as a marathon isn’t decided by the final 100 yards alone, we believe the dismissal of active management based on recent performance alone could be imprudent.
Active or Passive? Yes.
Like the ocean tides, active and passive management’s performance ebbs and flows. And as FIGURE 2 demonstrates, their performance cycles are clearly defined. The chart compares the rolling monthly 3-year performance percentile rankings for active managers with that of passive managers ranked within the Morningstar Large Blend category.
FIGURE 2 shows that while overall there is no clear winner over the past 30 years, there has been a clear winner in active vs. passive performance for multiple and sustained periods, followed by a trading of positions. Once again the recent outperformance of passive is evident, and is preceded by 11 years of dominance by active management, and so on.
The story that FIGURES 1 and 2 tell is clear. Just when it seems that active or passive has permanently pulled ahead, markets change, performance trends reverse, and the futility inherent in declaring a “winner” in active vs. passive is revealed anew.
No Clear Winner in Active vs. Passive Large-Cap Funds
Active Large Blend Category (%)
S&P 500 Index Funds (%)
Bold indicates winner
Past performance does not guarantee future results. Indices are unmanaged and not available for direct investment. Data Sources: Morningstar and Hartford Funds, 2/22.
* Active Large Blend is made up of funds from the Morningstar Large Blend category that are not index or enhanced index funds.
* S&P 500 Index Funds are represented by the Morningstar S&P 500 Tracking category.