Investing in active funds: what’s the point?

March 19, 2012

Active vs passive investment is a long-lasting debate: active funds will tell you they deliver alpha (extra returns), but for a fee. Passive investment simply tracks the index so it’s cheaper. The risk is you may underperform your peers.

New research from Thomson Reuters Lipper throws up an interesting twist in the debate: It found that less than half of the actively managed mutual funds in Europe outperformed their benchmarks over the past 20 years.

The proportion of funds that outperformed varied from 26.7% in 2011, 40% over 3 years and 34.9% over the past 10 years. While bond funds fare better over 3 years with 45.4% outperforming, the proportion tailed off dramatically over the 10-year period, falling to 16.2%.

For long-term investors, the fact that an active manager does not outperform in every calendar year is likely to be less significant than whether he/she can outperform over a longer period. However, the result here is equally unimpressive. The data showed that the proportion of equity funds beating benchmarks in terms of rolling returns fell to 39.7% over a 10-year period (and just 17.4% for bonds). Your best bet seems to be in active equity funds investing in Asia Pacific ex-Japan (54.4% over 10 years).

Despite the findings, active funds are a big industry: Assets of actively managed equity funds in Europe stand at just under 1.5 trillion euros, while index trackers have 160 billion euros and ETFs 139 billion euros. In other words, of the equity funds pot, passively managed products make up less than 17%.

Obviously, not everyone survives. Over the past 10 years in Europe,  3,400 funds have been launched every year on average while 2,400 have been closed or merged. In other words, there has been a net increase of 1,000 funds each year (across all asset classes and for both actively and passively managed funds).  But you are spoiled for choice: the current universe stands at around 35,000 funds.

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