With a few exceptions, Morningstar's most recent semiannual comparison of actively managed versus passively managed funds confirms once more that most active funds don't deliver enough bang after expenses.
The latest Morningstar Active/Passive Barometer report from the Chicago-based investment research company includes data through year-end 2015 that gauges active-manager success by looking at measures that include comparing their returns versus a composite of relevant passive index funds. The report also looked at the importance of fees.
Among the key takeaways: active funds generally underperform passive funds, particularly over longer time periods; active funds have higher mortality rates through mergers and closures; and the higher fees charged by active funds have a strong bearing on their higher failure rates.
“Higher-cost funds are more likely to underperform or be shuttered or merged away and lower-cost funds are likelier to survive and enjoy greater odds of success,” the report said.
Morningstar said the report isn’t trying to settle the active versus passive debate, but it’s clear that active funds have some built-in disadvantages. For example, active managers start off in a hole because their typically higher fund expenses come off the top. As such, the expectation of 'you get what you pay for' is turned on its head.
“You pay Ferrari prices and you're likely to get a lemon,” says Ben Johnson, Morningstar's director of global ETF research. “You pay for a Honda Civic [a low-expense index fund] and you're more likely to get Ferrari performance.
“It will always be difficult for active managers to produce better performance than their index peers,” he adds.
Of course, some active fund categories fare better than others. According to the report, value managers had better odds of long-term success than other types of active funds. In that vein, the lowest-cost mid-value funds experienced the greatest long-term odds of success (72%).
Morningstar says long-term success rates were generally higher among small-cap, mid-cap, foreign, and intermediate-term bond funds.
Morningstar uses “success ratios” to express the performance of funds that survived until the end of the research period and exceeded their index benchmarks in a given category. Some advisors welcomed Morningstar's work on fund survivorship.