Active funds still fail to beat the benchmark

by , 4th April 2018

Active European funds continue to underperform their benchmarks, according to new research from S&P.

S&P analysed the performance of 23 active fund categories for funds that are domiciled in Europe. The categories included well-known fund types such as ‘UK equity’ and ‘global equity.’

Look at this table which covers the 8 most popular categories:

% of European active equity funds outperformed by benchmarks*

Fund category Comparison index 1-year % 3-year % 5-year % 10-year %
Europe equity S&P Europe 350 38.9 45.8 59.6 75.8
Europe ex-UK equity S&P Europe ex-UK BMI 56.2 69.1 74.8 73.5
UK equity S&P UK BMI 46.4 59.6 54.1 75.2
UK large/mid cap equity S&P UK Large/Mid Cap 54.1 64.7 47.7 73.4
UK small cap equity S&P UK Small Cap 19.7 41.1 56.6 72.8
Global equity S&P Global 1200 52.7 82.3 86.2 94.9
EM equity S&P /IFCI 62.4 81.0 79.5 84.8
US equity S&P 500 67.1 88.4 93.0 93.4


*These are all pound sterling-denominated funds

In each category, a substantial majority of the funds failed to beat the benchmark over ten years. Remember these are all active funds where highly paid fund managers pick stocks for the fund.

It’s shocking to see that in the global equity class, almost 95% of funds failed to beat the benchmark over a decade. The data is better over one and three years but even then, there are plenty of active funds that haven’t delivered the goods.

The table illustrates the case for passive investing nicely. Granted, some actively-managed funds, where a manager picks the stocks, did perform well over the decade.  But it’s very hard to predict in advance which will be the out-performing funds. Whereas if you go for a traditional passive fund, where the fund invests in every stock in an index, you get a more predictable performance, moving in line with the index.

Survivorship bias

S&P’s data is particularly useful because it avoids ‘survivorship bias.’ Some comparisons of active and passive funds only include funds that were operating throughout the period under consideration – for example, at the beginning and end of a ten-year period. The problem with this approach is that it means that the worst active funds are often excluded from the comparison. That’s because the worst funds are often closed because their performance is so disappointing.

In other words, many comparisons of active and passive funds only look at the ‘survivor’ funds –hence ‘survivorship bias.’ This bias is important because when you pick a fund, you never know if it’s going to be a survivor or not, so a truly fair comparison between active and passive funds must include all the funds available at the beginning of the period under consideration.

So well done to S&P for avoiding this trap!

Smart beta

S&P’s research is only comparing conventional passive funds with active funds. Conventional passive funds weight their holdings according to the market caps of the companies in the index that’s being tracked.

It would be interesting to see similar long-term performance data for smart beta funds or ETFs. These are passive funds where the weightings are made according to other factors such as size, value or momentum. These Smart beta funds are still following a passive approach because they follow a rules-based approach. Stocks aren’t being picked by an expensive fund manager on Wall Street or the City.

There’s a fair amount of data out there looking at how a particular factor, such as value, has performed over time. But I yet haven’t seen a comparison between all active funds and passive smart beta funds.

Small caps

S&P has also published data on the relative performance of different sectors in 2017.

One striking finding is that UK Small cap funds performed much better than their UK Large and Mid-Cap peers. 80% of actively managed UK Small-cap funds outperformed their benchmark for the year, compared with 46% for the UK Large and Mid-Cap category.

US and emerging market equity funds – all domiciled in Europe remained among the region’s worst-performing active fund categories. Euro and sterling-denominated funds investing solely in US equities provided average returns that were below their local currency benchmark for all periods analysed. Less than one-third of these funds outperformed in 2017 and less than one-tenth outperformed since 2008.

The poor performance of US active funds isn’t surprising. The US is an especially efficient market where it’s hard for stock pickers to find under-priced investment opportunities. However, the poor performance of the emerging market active funds, compared to their benchmark, is more surprising as emerging markets aren’t normally seen as efficient. Perhaps emerging stock markets are more mature than some folk have realised.