Morningstar - Q4 2020 - 8

Dispatches

Busting an ActiveFund Myth Index funds
performed just as well
during the sell-off.

Phillips Curve

Diversity of Thought
Ivory Towers

What If Inflation Isn't Dead?

Policy

26
27

LETTER FROM THE BOARD

Ben Johnson

But six months isn't a sufficient time horizon
for investors to draw conclusions regarding the
odds of partnering with successful active
managers, as their success rates are very noisy
over short time frames. They can fluctuate wildly
from year to year, depending on what's going
on in the markets and how that reflects on
the systematic biases in their portfolios as well as
in the indexes we measure them against.
For example, many active bond funds tend to take
more credit risk than their indexed peers. Their
success rates tend to rise when this risk is
rewarded and fall when credit markets are roiled,
as they were earlier this year.

Another Fiduciary Rule?
Global Briefs

Americas
Greater Europe
Australia & New Zealand
Asia

The coronavirus sell-off and subsequent rebound
tested the narrative that active funds can
navigate market volatility better than their index
peers. The midyear installment of the
Morningstar Active/Passive Barometer looks at
active funds' performance through the first
half of 2020 and shows that there's little merit to
this notion. (Morningstar Direct clients can
download the full report.)
Across the 20 Morningstar categories examined
in this latest report, 51% of active funds both
survived and outperformed their average
index peer during the first half of the year. Active
funds' performance was neither categorically
better nor worse than that of their index peers
during this period.
When viewed as a whole, active funds had a
roughly 50/50 chance of succeeding during
the year's first half, although results varied widely
across asset classes and categories. For example,
actively managed U.S. stock funds didn't
fare as well as foreign-stock funds. Just 48% of
the former cohort outgained their average
passive peer in the first six months of 2020, while
nearly 60% of the latter group did.
Overall, active bond funds' showing was relatively
poor. From January through June, 40% of active
funds in the intermediate core bond, corporatebond, and high-yield bond categories both survived
and beat their average passive counterpart. Many
bond funds were caught offside in a period that
punished credit risk and rewarded interest-rate risk
as credit spreads widened and rates fell.

Morningstar Q4 2020

Looking back over longer horizons yields useful
signals-data that investors can put into
practice while selecting active funds. In general,
actively managed funds have failed to survive
and beat their benchmarks, especially over longer
time horizons ( EXHIB IT 1 ). Only 24% of all
active funds topped the average of their passive
rivals over the 10-year period ended June 2020.
However, success rates vary across categories.
Long-term success rates were generally
higher among foreign-stock, real estate, and bond
funds and lowest among U.S. large-cap funds.
Investors can use this data to home in on areas
of the market where they have better odds
of picking winning funds.
Sizing the Payoffs and Penalties
Investors should understand the chances of
finding a successful active fund as well as the size
of the prospective payout for picking a winner
and the penalty for landing on a loser. The Active/
Passive Barometer contains this information
in the form of plots of the distribution of 10-year
excess returns for surviving active funds versus
the average of their passive peers.

Much like success rates, these distributions vary
widely across categories. In the case of U.S.
large-cap funds, the distributions skew negative.
When considered in conjunction with the low
long-term success rates in these categories, this is
an indication that the likelihood (as measured by
their success rates) and performance penalty
(as manifest in the negatively skewed distribution)
for picking an underperforming manager tends

Morningstar - Q4 2020

Table of Contents for the Digital Edition of Morningstar - Q4 2020