Active management fails to impress amid 2020 markets

The Morningstar analysis of results so far this year does not bode well for active managers

Actively managed funds outperformed their passively managed counterparts on average during the first half of 2020, but that showing is far from a solid endorsement of higher-cost active management, according to Morningstar Inc. analyst Ben Johnson.

“The whole notion of a stock pickers market is a fiction, and it belongs in same category as Santa Claus and the Easter Bunny,” Johnson said, referring to claims that this year’s market volatility plays into the hands of active managers.

Morningstar’s research showing that 51% of active funds beat their average index peer over the first six months of 2020 is interpreted as both a narrow and nuanced victory.

“The narrative often spun by many active managers is that they are somehow better positioned to add value, but this research shows that that narrative doesn’t hold water,” Johnson said. “Math alone would show that half would do better and half would do worse than an index.”

From a universe of nearly 4,400 funds that account for approximately $13.1 trillion in assets, or about 66% of the U.S. fund market, Morningstar found that just 48% of U.S. stock funds outgained the average passive peer index, while 60% of foreign stock funds beat their benchmarks.

When the performance is separated into Morningstar’s 20 fund categories, the picture becomes clearer: Active management alpha is more prevalent as strategies get farther from the beaten path.

Only 35% of U.S. large-cap blend funds, for example, beat their benchmarks during the study period, which compares to the 72% of European stock funds that beat their benchmarks.

The U.S. and global real estate fund categories were the strongest actively managed categories, with more than 80% of those active funds beating their benchmarks.

Active fixed-income funds were generally laggards over the six-month period through June 30, with only 40% of the intermediate core, corporate and high-yield bond funds beating their benchmarks.

The Federal Reserve’s monetary policy has led to historically low interest rates, presenting a unique challenge for bond fund managers, said Todd Rosenbluth, director of mutual fund and ETF research at CFRA.

“Active bonds funds struggled as taking on credit risk relative to the index was not rewarded,” Rosenbluth said. “Investors have been more comfortable and stayed more with active bonds despite cheaper competition, and when volatility spiked, active investors lost out.”

Paul Schatz, president of Heritage Capital, agreed that it takes a special kind of fixed-income manager to navigate the current bond market.

“I’m not at all surprised by the results as it seems like there is a handful of really great active fund managers and the rest have continued to position for the end of the 40-year bull market in bonds, which hurts returns,” he said. “Also, in fixed income, with the range of returns much narrower than in equities, fees hurt even more.”

Fund expense ratios are a factor across the board. While Morningstar calculated benchmark performance net of fees for the most accurate performance comparisons, it found that over the 10-year period through June 30, the least expensive funds beat their benchmarks about twice as often than the most expensive funds.

Over that period, the least expensive funds beat their benchmarks 34% of the time, compared to 16% for the most expensive funds.

“Given that investors can choose nearly free S&P 500-based and Bloomberg Barclays Aggregate bond-based funds, investors need to be rewarded for paying a premium,” Rosenbluth said. “The best funds are the ones that have strong track records and low fees since the latter is a key driver of future performance success.”

Johnson’s takeaway is that short-term market volatility is a lousy indicator of a fund’s long-term performance potential.

“What you see in these shorter-term numbers is a lot of noise,” he said. “Adding value as an active manager is a tough slog, so if you’re going to pass judgment on active management, it has to be done over a longer time frame.”