In a year when markets have been falling and long-standing trends have gone into reverse, you might have expected active fund managers to perform better than the machines that simply track the index. But the latest AJ Bell Manager versus Machine report shows that’s not the case.
The report compares active and passive fund performance by looking at over 1,000 open-ended funds across 7 major equity sectors. The report reveals:
Less than a third (30%) of active equity funds have outperformed a passive alternative so far this year
- Down from 34% in 2021
Active performance has been particularly miserable in the UK, where only 12% of active funds have outperformed a passive alternative
- Mid and small cap exposure has proved an Achilles heel for active managers
- UK active fund investors have not enjoyed the relatively strong performance of the FTSE 100
40% of US funds outperformed, a marked improvement on just 19% last year
- It’s been a good year for active funds in this region by their own modest standards
- The tech sell off has played a big part in fund performance
Active Global Emerging Markets funds haven’t fared well, with only 21% outperforming
- The passive machines have coped better with market disruption
The most costly UK tracker fund is 21 times more expensive than the cheapest
- Even passive funds have shown a wide range of returns in some regions, but it’s not all down to charges
Laith Khalaf, head of investment analysis, AJ Bell:
“2022 is not shaping up to be a good year for active fund managers. Overall, only 30% have beaten a passive alternative in the first half, down from 34% in our 2021 Manager versus Machine report. That’s despite choppy market conditions which one would normally expect to favour the flexibility of active funds over the rigid investment strategy of index trackers.
“While there has been a considerable improvement in active fund performance compared to last year amongst US funds, and a modest improvement in Global funds, very few active managers in the UK All Companies sector have been able to beat a typical tracker fund. There are so many funds in this sector that a poor showing here has been a big swing factor for active management as a whole, with the result that overall active fund performance has deteriorated in 2022 compared to last year.
“The longer term figures look more positive for active funds, with 45% outperforming a passive alternative over 10 years. That’s less than half of course, and will be flattered by survivorship bias, as unsuccessful funds will tend to wind down or be merged into others. Nonetheless that does still mean a large chunk of active funds have outperformed an index tracker over the last decade, which gives active fund investors some cause for optimism. So does the fact that the success of active managers is not uniform across fund sectors, which furnishes investors with the opportunity to pick and choose which parts of their portfolio they populate with active and passive strategies.”
Proportion of active funds outperforming a passive alternative
|
|
% of active funds outperforming passive |
|||
|
IA Sector |
H1 2022 |
5 years |
10 years |
2021 |
|
Asia Pacific Ex Japan |
27% |
47% |
59% |
26% |
|
Europe Ex UK |
49% |
46% |
57% |
53% |
|
Global |
31% |
26% |
28% |
25% |
|
Global Emerging Markets |
21% |
37% |
42% |
50% |
|
Japan |
40% |
43% |
51% |
47% |
|
North America |
40% |
25% |
28% |
19% |
|
UK All Companies |
12% |
31% |
63% |
41% |
|
Total |
30% |
33% |
45% |
34% |
Source: AJ Bell, Morningstar total return in GBP to 30th June 2022
2021 data from 1st Jan 2021 to 1st Dec 2021
The Achilles heel for UK active managers
“The most widespread underperformance has been evident in the UK All Companies sector, where only 12% of active funds have managed to beat a passive alternative, compared with 41% in 2021. The average UK active fund returned -13.5% in the first half of 2022, compared to -4.4% from the average passive fund.
“Exposure to mid and small cap areas of the market has proved to be an Achilles heel for UK active managers in 2022, though it’s been a big tailwind in the longer term, as Table 3 and Table 4 in the report show. While energy stocks have acted as a buoyancy aid for the FTSE 100 so far in 2022, sentiment towards the growth stocks that feature heavily in the small and mid-cap areas of the London Stock Exchange has turned sour, and resulted in steep price falls this year.
“The propensity of active fund managers to be underweight large caps and overweight mid and small caps therefore means that many UK fund investors haven’t benefited from the relatively strong performance of the FTSE 100 in 2022. The UK’s benchmark index fell by just 1% in the first half of the year. The average active fund fell by 13.5%.
A ‘good’ year for US active managers
The story of the US stock market this year so far has been dominated by the sell-off in growth stocks, especially within the technology sector. These stocks dominate the top of the US index, and by extension, the funds that track it. Looking at some of the biggest tech names in the index, they have fallen by on average 30.9% so far this year, compared to the average S&P 500 stock which has fallen 6.7% (in pounds and pence - see Table 5 in the report).
The sell-off in big tech should have afforded active managers in the US an opportunity to play catch up on their passive rivals, who blindly buy into the biggest companies in the market, come what may. However, active funds have been loading up on tech too. The average technology exposure of US active funds was only just shy of passive funds at the beginning of the year, making up 25.4% of the typical active fund compared to 25.9% of the typical tracker. Nonetheless that means just under half of active funds were underweight technology stocks, and combined with the scale of poor performance from the tech sector, that has helped to lift the number of active funds outperforming, from a pretty low base.
Longer term performance of US active funds has been disappointing, with only 28% outperforming the average passive fund over the last ten years. This probably comes down in part to active managers’ propensity to be underweight large caps (see Table 6 in the report). In the long term, the underweight position in large caps has had the opposite effect on US active managers than in the UK All Companies sector. That’s because in the US it has been the large cap stocks which have led market performance over the last ten years, leaving mid and small caps trailing in their wake (see Table 7). Being underweight large caps compared to a passive fund therefore leaves active managers at a performance disadvantage, simply by virtue of the size profile of stocks within their portfolio.
Tracker fund charges and performance
As Table 12 in the report shows, there is still a wide range of charges applied to tracker funds in each sector. The UK is a particularly stark example, where the most costly tracker fund is 21 times more expensive than the cheapest. It is little wonder that the UK trackers with the highest charges also find themselves at the bottom of the passive performance table over ten years. There’s simply no reason for investors to hold expensive trackers when they can buy a fund that does the same job at a fraction of the annual cost, which just means more money in their pocket at the end of the day.
While a spread of performance is expected amongst active funds, it may come as some surprise to observe the range of outcomes delivered by passive funds in certain sectors. Mostly this comes down to index selection, though over the long term, charges play a part too. For more details see Table 10 in our report.
Conclusion
2022 has not been kind to investors, and it’s notable that positive returns have been largely absent across both active and passive funds in the seven equity sectors covered in this report. In such febrile market conditions, one might expect managers to come out on top of the machines, but that hasn’t proved to be the case.
While recent performance is, almost by definition, more newsworthy, it’s the long term picture which is most important for investors when considering whether to invest actively or passively. While the statistics suggest that overall picking an active fund that outperforms over the long term is no better than a coin toss, investors can of course significantly tilt the odds in their favour. They can split their own portfolios between fund managers and passive machines, based on where they see the biggest rewards from active management, and indeed the most compelling performance prospects from specific active fund managers.
Unlike the most vociferous disciples of active or passive management, investors can afford to be pragmatic, not dogmatic, in their fund selection. By picking competitively priced tracker funds, and supplementing this with a bit of judicious active fund selection and diversification, they can give themselves a good chance of achieving portfolio outperformance in the long run, through a combination of both active and passive strategies.
If you haven't already, take a look at the AJ Bell Manager versus Machine report.
