Coronavirus sell-off revealed “little merit” in idea that active managers navigate volatility better than passive counterparts

Storm clouds

The majority of active managers in Europe and the US did not seize the “once-in-a-decade opportunity” presented by the coronavirus pandemic to demonstrate superior returns to passive options, according to new data from Morningstar.

Active funds have struggled to attract investors in recent years, with investors’ trust in managers declining and high fees cutting into returns.

“In theory – one often posited by active fund managers – the early-2020 volatility caused by the coronavirus pandemic should have been a once-in-a-decade opportunity for active fund managers to deliver excess returns, shielding investors from a vicious drawdown in global markets,” say Dimitar Boyadzhiev and Ben Johnson, the report’s authors.

Morningstar measured the performance of Europe-domiciled active funds against passive peers in a semi-annual report on its Active/Passive barometer.

“In practice, only about half of active stock funds and one third of active fixed income funds bested their average passive peer during the first six months of 2020,” say the authors.

The data provider says that the reason active stock funds performed better than bond funds is that stock funds typically hold more cash than their passive peers. This cushioned them against the worst of the coronavirus sell-off in the first quarter of 2020.

Fixed income funds also suffered because they had taken on more credit risk than their passive counterparts. 

Long-term performance was also weak among active managers. Over 10 years through June 2020, active managers in only two fund categories, UK mid-cap and Denmark, on average outperformed their average passive counterparts. 

Most single-country passive strategies performed better than active funds in the same country.

Almost 35 per cent of the UK large-cap managers beat their passive counterparts over 10 years, and the success ranged between lows of 5.6 per cent and 28.3 per cent for US large-cap blend as well as Japan large-cap, France large-cap, Germany large-cap, and Switzerland large-cap strategies.  

Major market segments like global large-cap blend and Europe large-cap blend also had low rates of outperformance by active managers, at 6.8 per cent and 13.2 per cent respectively.

“The coronavirus sell-off and subsequent rebound tested the narrative that active funds are generally better able to navigate market volatility than their index peers. Active funds’ performance through the first half of 2020 shows that there’s little merit to this notion,” write Boyadzhiev and Johnson.

“Across all 20 categories we examined, 51 per cent of active funds both survived and outperformed their average index peer during the first half of the year.”

Morningstar says that investors have tended to favour cheaper, higher-quality funds, which was reflected in the funds’ success rates.

“The cheapest funds succeeded about twice as often as the priciest ones (34 per cent success rate versus 16 per cent success rate) over the 10-year period ended 30 June, 2020. This not only reflects cost advantages but also differences in survival, as 65 per cent of the cheapest funds survived, whereas 49 per cent of the most expensive did so.”