AJ Bell: 36% of active funds outperform passive in 2023

Funds that outperform hold lower average fee than underperformers, according to the platform

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Over a third of active funds outperformed their passive counterparts in 2023, an uptick of nine percentage points from last year’s 27%, according to AJ Bell’s ‘Manager versus Machine’ report.

The report also revealed that, while the average charge across 10 years for overperforming funds is 86bps, the average fee for underperforming funds increases to 99bps, an issue which has been brought to attention by the FCA’s consumer duty regulation highlighting value for money. While the report claims the data is not sufficient in providing ‘a causal relationship between lower active charges and better performance’ it does ‘undermine the idea that higher charges are associated with better performance from active funds’.

See also: AJ Bell: Tracker fund charge discrepancies are eating into investor capital

Global active funds proved to be a sticky spot for active managers in 2023 as only a quarter managed to outperform the passive vehicles, while active managers made strides in the UK, jumping from just 13% outperforming in 2022 to 44% in 2023. This percentage, however, stills sits far below the 85% of active managers who outperformed in 2021.

Laith Khalaf, head of investment analysis at AJ Bell, said: “This also highlights how the fortunes of active managers are not simply dictated by skill, or lack thereof. Market conditions play their part too.

“As things stand there have been long running trends in markets which have been negative for active managers on the whole, in particular the hegemony of large, US tech companies.”

For 2023, global emerging markets was the best spot for active investors, with 57% outperforming, followed by the UK and the US. However, when considering a 10-year scope, only 44% of active funds kept above the index and the active average return for 10 years only hit 56.5% while passive reached 60.5%.

“While all active fund investors expect outperformance, it’s not statistically possible for all managers to outperform,” Khalaf said.

“Investors therefore need to pick their battles wisely. This means acknowledging that some markets have proved more difficult to beat than others, and selecting active fund managers in whom they have a high degree of conviction.

“A long and successful track record suggests outperformance has been achieved by skill and not just luck, but it’s still no guarantee for the future, so any active portfolio should include several managers for diversification.”

Within passive funds, there is also a large fee disparity in particular sectors. For the UK, the most expensive fund sits at a 1.06% ongoing charge while the least expensive is just 0.05%. Global funds also have a range of 0.52%, and sectors including Asia Pacific ex Japan, global emerging markets, Japan, and the US all have fees with disparities ranging between 0.21 and 0.25%.

“Investors in passive funds shouldn’t be too complacent, either. They still need to make some active decisions in terms of their index selection and picking a competitively priced fund,” Khalaf said.

“The performance gulf between the most expensive and cheapest passive strategies is quite startling, and this is a gap investors can bridge quite easily by simply switching funds.”

In total, active funds have lost £9bn in net retail outflows in the past five years, while passive funds have gained £75bn in net inflows. This has put 2023 on track for the lowest number of active fund launches in a year since 2008, a number which has declined since 2019.

“There also has to be a question of whether passive investing is becoming a bit of a self-fulfilling prophecy. Passive flows allocate money to markets simply based on company size, rather than fundamentals,” Khalaf said.

“This helps support the share prices of the big at the expense of the little, thereby rewarding passive strategies and active managers who buy into the same approach with better performance. These funds may then attract more flows compared to active managers taking a contrarian view, and the cycle continues.

“It’s easy to see how a flood of passive money might help to entrench success and failure, both in markets and in fund management. There will come a saturation point for passive funds, but it shows no sign of making an appearance just yet.”

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