This story first ran in Financial Advisor IQ's sister publication, Ignites.
Active large-cap managers are on track to have their best showing against the S&P 500 index since the wake of the financial crisis – even if more than half are still lagging their benchmarks, new research shows.
During the first half of 2022, 51% of active large-cap equity funds underperformed the S&P 500 index, according to a midyear report from S&P Dow Jones Indices, published Thursday. That is down considerably from last year, when 85% of active large-cap funds lagged their benchmarks, and 2020, when 60% underperformed .
The last time fewer active funds underperformed the S&P 500 was in 2009, when 48% lagged the benchmark, the S&P review says.
“Declining markets make active management skills all the more valuable, and our report shows that a significant minority of active managers were able to outperform in several categories,” the report states. The S&P 500 index was down 28% in the first half of this year.
Active managers have long touted their value in protecting investors from market drawdowns, but many have seen fewer gains from picking individual stocks than from underweighting the stock market altogether by socking money in cash, Morningstar data suggests. Without the cash bump, the average active mutual fund would lag the Russell 1000 stock index, recent research from Goldman Sachs suggests.
The halo around active comes as many companies have started to put their stock- and bond-picking strategies into the ETF wrapper. Active ETF launches are on track to outpace index-based debuts for the third straight year, according to Morningstar data, with big managers like Capital Group, DoubleLine and AllianceBernstein jumping in with their first such ETFs this year.
Active ETFs tend to have lower fees than mutual funds, which gives them a better shot at beating an index, said Todd Rosenbluth, director of research at VettaFi. S&P’s analysis compares active funds’ performance to an index, which does not charge any fees, rather than to a fund, which has an expense ratio.
But active ETFs likely face many of the same challenges as mutual funds in outperforming over the long haul, he said.
“No one is investing in a mutual fund or ETF for a six-month period,” Rosenbluth said, referring to the recent period of strong performance. “They’re looking for strategies with a five-, 10-, 15-year time horizon, and time and time again, it’s hard for active management to beat the benchmark.”
Nine out of 10 large-cap funds trailed the S&P 500 over the 10-year period ended June 30, according to S&P’s report. None of the 18 slices of the U.S. equity active fund market had more than 35% of active funds beating their relative benchmark over a decade. Mid-cap growth funds performed the best over the 10-year period, with 65% underperforming the index. Large-cap growth funds had the worst showing, with 97% lagging over a decade.
There are several reasons for the poor showing, Rosenbluth noted, but part of it is because most active stock funds don’t survive to see their 10th year. And if they do, it’s often not in the form they were originally launched, he noted.
Just 62% of funds in Morningstar’s large-cap blend category made it to their 10th birthday, according to December 2021 data. Only 32.8% of funds launched at least 20 years ago as of December still existed at year-end 2021. Just 9.5% of active large-cap blend funds that debuted before January 2011 survived the decade and beat their passive-fund counterparts, the report notes.
S&P’s midyear report noted that there are some differences in relative performance among size and style slices of the domestic equity universe.
During the first half of 2022, 67% of active mid-cap core and 55% of mid-cap value active funds beat their benchmarks, the S&P MidCap 400 and S&P MidCap 400 Value, respectively.
But growth-oriented strategies across all market caps seemed to struggle. Only 21.5% of large-cap growth, 11.3% of mid-cap growth and 39.1% of small-cap growth active funds beat their benchmarks between January and June, the report shows.
S&P and other industry watchers long have pointed to active managers’ style drift as a source of outperformance, particularly for mid-cap funds, where managers tend to focus on the larger or smaller sides of the spectrum, as reported.
In some cases, this drift is important for creating active share distinctions between funds and their benchmarks, VettaFi’s Rosenbluth says. This can come in handy when the off-benchmark portfolio companies do well, or decline less than the index, he said, but also can work against shops when the benchmark holdings are in favor.
The modest bump in performance has not helped sales of active equity funds. Active U.S. equity mutual funds bled $143.9 billion year to date through August, including $106.7 billion in the first half of the year, according to data from Morningstar Direct. Passive U.S. equity mutual funds, excluding leveraged and inverse products, generated $48.5 billion in sales in the first half. In July and August, the funds bled $2.6 billion.
In the ETF wrapper, active U.S. equity products generated $13.3 billion in net sales year to date through August, including $11.1 billion during the first half, according to Morningstar’s database. Passive domestic equity ETFs, meanwhile, raked in $148.9 billion during the first eight months of the year, including $114.4 billion during the January-to-June period.