AJ Bell’s latest Manager versus Machine report paints a picture of active management under significant pressure, both in terms of performance and flows. Just 36% of active managers beat the average passive alternative in 2023 across seven key equity sectors. That might not sound like a lot, but it’s actually up from 2022, when only 27% of active managers beat a passive comparator. Meanwhile £9 billion has been withdrawn from active open-ended funds by retail investors over the last five years, while at the same time a net £75 billion has flowed into passive strategies, based on AJ Bell analysis of Investment Association data. The full version of our Manager versus Machine Report can be viewed here.
Laith Khalaf, head of investment analysis at AJ Bell, comments:
“Active equity managers find themselves under the passive cosh once again in 2023. Just 36% of active managers beat the average passive alternative so far this year. That’s up from 27% in 2022, but another year of lacklustre performance is going to do little to attract investors to the benefits of active management. That is reflected in fund flows, where over the last five years £9 billion has been withdrawn from active funds, and £75 billion has flowed into passive funds, based on Investment Association data. Index trackers are winning the game both on and off the pitch.
“The performance of active funds in the global sector against a passive comparator has been particularly feeble, with just a quarter outperforming. This is the most popular sector with UK retail investors and so weak performance here has particularly widespread repercussions. The good news is returns from the global market have been so strong, that over the last 10 years it’s been significantly better to be invested in a bottom quartile global fund than a first quartile UK fund (107.9% versus 69.7%). Investment returns over the last decade have all been about location, location, location. So even investors in underperforming global funds are probably surprisingly happy with their lot.
“One year is too short a time frame over which to fairly judge the performance of active managers, but unfortunately things don’t look better in the longer run. Over 10 years just 32% of active equity managers have beaten a passive alternative. This is actually down from 56% since our 2021 Manager versus Machine Report. The downward shift has been triggered by a bad couple of years for UK mid and small caps, which have dragged down the performance of active managers investing specifically in UK equities. In our 2023 report, 36% of these active funds in the UK sector have outperformed over 10 years, and that compares with 85% in our 2021 report. This also highlights how the fortunes of active managers are not simply dictated by skill, or lack thereof. Market conditions play their part too. As things stand there have been long running trends in markets which have been negative for active managers on the whole, in particular the hegemony of large, US tech companies.
“There also has to be a question of whether passive investing is becoming a bit of a self-fulfilling prophecy. Passive flows allocate money to markets simply based on company size, rather than fundamentals. This helps support the share prices of the big at the expense of the little, thereby rewarding passive strategies and active managers who buy into the same approach with better performance. These funds may then attract more flows compared to active managers taking a contrarian view, and the cycle continues. It’s easy to see how a flood of passive money might help to entrench success and failure, both in markets and in fund management. There will come a saturation point for passive funds, but it shows no sign of making an appearance just yet.
“While all active fund investors expect outperformance, it’s not statistically possible for all managers to outperform. Investors therefore need to pick their battles wisely. This means acknowledging that some markets have proved more difficult to beat than others, and selecting active fund managers in whom they have a high degree of conviction. A long and successful track record suggests outperformance has been achieved by skill and not just luck, but it’s still no guarantee for the future, so any active portfolio should include several managers for diversification.
“Investors can of course blend both active and passive strategies, to get a bit of the best of both worlds. This is particularly relevant when you consider there are some areas of the market which are not well served by passive vehicles or which generally favour an active approach, such as producing income, preserving capital or investing in small caps. Investors in passive funds shouldn’t be too complacent, either. They still need to make some active decisions in terms of their index selection and picking a competitively priced fund. The performance gulf between the most expensive and cheapest passive strategies is quite startling, and this is a gap investors can bridge quite easily by simply switching funds.”
Manager versus Machine 2023 highlights
Active outperformers
Sources: AJ Bell and Morningstar to 30 November 2023
