It’s a refrain so familiar that it could practically be sung on karaoke night: it’s better to invest in index-based funds than with active managers. But new research suggests that while the statement is true in general, there are exceptions to the rule.
“Over the past 10 years, more than half a trillion dollars has flowed out of actively managed U.S. stock funds and into passively managed U.S. index funds,” noted Derek Horstmeyer, assistant professor of finance at George Mason University’s Business School, in a recent column for the Wall Street Journal. “Average returns for the active funds during this period lagged behind those of index funds tracking the same asset class.”
But he went on to say that in some pockets of the world, active funds are getting average returns that trounce those of their passive peers. This conclusion, he said, was based on a comparison of publicly listed open-end mutual funds around the world over a span of 10 years, focusing on regions or countries with at least 200 Morningstar-tracked funds each dedicated to them.
“First, looking at the fund performances inclusive of fees and broken down by the geographic areas … in only one place did active managers vastly outperform their passive equity benchmarks after fees over the past five years: India,” Horstmeyer said.
Focusing on dollar-based performance over the five years ended January 2019, he said, reveals an average annualized return of 10.55% for active managers focused on Indian stocks. That translated to an average annualized excess performance of 2.88% over the past five years for India-focused managers; expanding the window to 10 years shows annualized excess performance of 3.01%.
“In three other countries, actively managed funds showed a significant advantage in either five-year or 10-year comparisons, or in both,” he added. Active funds that invest in Mexico demonstrated a 1.41% edge in excess performance over five years, and 1.15% over 10.
The 10-year picture also showed passive-benchmark outperformance for funds focused on China (1.86%) and the UK (0.9%), but that narrowed to just 0.1% and 0.02%, respectively, for the five-year period.
Three other countries also showed the average active manager generating slightly positive excess returns over the past 10 years: Canada (just over 0.5%), Japan (slightly more than 0.5%), and Australia and New Zealand (just under 0.25%).
“Another indicator of talent that investors look for is fund managers’ ability to consistently beat their peers over time,” Horstmeyer noted. Consistent with other similar research, he and his colleagues found that most fund managers who were among the top half of performers from 2009 to 2013 did not maintain their top-half ranking over the next five years from 2014 to 2018.
Based on their analysis, only active managers of funds investing in Mexico, India, and Africa were able to maintain outperformance over their peers. In Africa’s case, Horstmeyer noted, this is not necessarily a mark of achievement, as active funds that focus on Africa underperformed their benchmark by an average of 2.2% annually, after fees, over a 10-year period.
“But, of those active managers who were in the top half of their peers from 2009 to 2013, two-thirds came out in the top half again from 2014 to 2018, suggesting some persistence in ability,” he added.
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