HORAN Capital Advisors

Knowledge College Q1 2019: An Update on the Active vs. Passive Debate

Given the increase in the number of index funds in the current 10-year period ending December 2018, we have separated the results for active and passive:

  • 83% of ten-year top-quartile active managers were unable to  avoid at least one three-year time period in the bottom half of their peer group. This is the lowest result to date, relative to 92, 90, 85 and 89% in our 2015, 2012, 2010 and 2007 studies, respectively. We believe the most recent lower outcomes is partially driven by no material drawdown in the most recent 10-year period, a unique circumstance compared to previous studies.
  • Top-quartile active managers on average spent 6.2 consecutive quarters below the median of their peer group.

Our findings remain consistent and support our previous conclusion that the majority of the best managers over longer periods of time will  periodically struggle relative to their peers.While fewer active  managers are breaching the bottom half of the peer group over the recent 10-year time period on a relative basis, on an absolute basis the number is still high. Our findings continue to suggest investors who select and terminate active managers based on short-term performance results are likely to miss the highest long-term  performers.

An investor might ask how more top-quartile managers have persistently stayed above the peer group median. Given the rise of passive investing through the last 10-year bull market, our findings indicate this phenomenon is largely driven by Large Cap equities and Intermediate Bonds. We found top-quartile managers in Intermediate Bonds allocated more to spread sectors such as credit over the last 10 years, with allocations to securities rated BBB and below averaging 11% higher than the peer group median. In Large Cap equities, most index funds never dropped below the 50th percentile. As such, managers that exhibited less market risk were destined  to decline in peer group ranks, as managers that took on at least full market risk were able to compete with the index. Finally, the -year period ending 2015 is far  different from the current period, in that maximum drawdowns and duration of drawdowns were less pronounced as we move further away from the Great Financial Crisis in 2008.

Furthermore, we examined the performance patterns of index funds with ten-year track records and found that passive investing does not always outperform the peer  group median. Of the 17 asset classes included in the study, Large Cap Value, Core, Growth, and Mid Cap Core were the only asset classes that had index funds  avoiding a three-year time period in the bottom half of their peer groups. Our findings indicate that index funds in the remaining 13 asset classes were unable to shield  investors from volatility in relative performance compared to active peers, as index funds spent, on average, 24 percent of rolling three-year time periods in the bottom half  of their peer groups – despite the advantage of a lower fee. The following chart illustrates the relationship between relative performance to peer group rankings, which  displays a sample of asset class’ rolling three-year batting average over the last decade. Our observations include:

  • 100% of top-quartile Intermediate Bond  active managers outperformed their index rolling  three-year periods generating positive excess return.
  • However, by contrast top-quartile Large Cap Core  active managers only outperformed 55 percent of  rolling three-year periods – only slightly better odds  than flipping a coin. These findings illustrate how  passive investing proves to be a superior  alternative in certain asset classes where active  managers are more likely to underperform.


As our data suggests, both the path to outperformance  and the probability of outperformance are important  elements for investors to consider. 83% of top-quartile mangers finding their way into the bottom half  of their peer group for at least a three-year period  suggests patience is required for success with active  management. Moreover, the likelihood of success for  active management is not uniform. Investors may  benefit to minimize exposure to areas where the  probability of success for active managers is low and  take advantage of those areas where success rates  are higher.