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Education - April 29, 2019

Can Active Management Still Add Alpha?

A unique approach to the age-old active versus passive management debate.

Executive Summary

  1. Selecting the correct asset class tilt is ~10X as important as deciding whether to invest in Active vs. Passive Funds. (TABLE 1)
  2. Actively managed funds outperform passively managed funds by ~2 percentage points per annum, on average. (TABLE 2)
  3. Over the last 20 years, the calendar annual returns for Active Funds studied outperformed their respective passive benchmarks ~57% of the time, across all asset classes. (TABLE 3)
  4. More than ⅔ of the time, actively managed equity funds are more consistent and less volatile than their counterpart passive funds; actively managed fixed income funds are far less consistent and more volatile. (TABLE 4)
  5. Selecting the “right” actively managed equity fund can lead to 10–30x greater returns, in relation to passive investing. Selecting the worst actively managed fund can underperform the index. (TABLE 5)


As an investor or advisor, it’s imperative to understand that decisions on asset class mix, actively or passively managed funds, and strategically appropriate tilts therein, are major factors in achieving investing goals and meeting risk/return profiles. All of these issues require attention, but the viability of Active Management in particular has recently been called into question. As such, sentiment regarding active and passive strategies has seen considerable movement over the last few years.

From the start of 2015 through September 2018, about $410 billion has moved out of actively managed funds, according to Morningstar. The active-passive debate has been, and continues to be, a contentious one, with time period samples that support each approach. The goal of this study is to answer the following question: with the continuing rise in popularity of passive funds and the flow of investors’ money into indexing strategies, can active management still add alpha?

In the tables and analysis following, metrics presented for Active Funds in each asset class are a simple average of the 25 largest (by assets under management as of December 2018) actively managed funds with a minimum 20 years of testable performance and manager(s) tenured 10 years or more. Metrics presented for the Passive Fund are those of a single, investable index fund that tracks the same index against which the active funds in each asset class are benchmarked (e.g. in the US equity asset class, Passive Fund metrics are those of SPDR ® S&P 500 ETF (SPY)).

The metrics employed in this analysis are as follows: annual total returns (net of operating fees only), one-year Sharpe Ratio, annualized monthly standard deviation of returns, and 30-day max drawdown.

Before You Decide on Active vs. Passive…

When facing a decision between an actively managed fund and its indexing peer, it’s important to acknowledge a much more pivotal decision — asset allocation.

When considering the five asset classes included in this analysis — US Equity, International Equity, Fixed Income, US Small & Mid Cap Equity, and Emerging Markets Equity — we found that the investor’s asset allocation results in a 10x greater performance impact when compared to an investor’s decision between an active fund and a benchmark fund.

TABLE 1 below illustrates the annual return percentage-point spread between the average active fund and its benchmark for the five asset classes analyzed. Similarly, TABLE 1 also shows in the rightmost column the annual return percentage-point spread between the best- and worst-performing asset class for both the average active funds and passive funds.

For example, an investor’s choice between an active US Equity fund and a passive US Equity fund would result in an annual return of +/- 2.8 points, on average; however, an investor who chooses a passive fund in the best-performing asset class in a given year would face an annual return of +/- 31.4 points compared to the Passive Fund in the worst-performing asset class.

Regardless of an investor’s choice, active fund or passive fund, deciding between asset classes is markedly more impactful on performance.

Read More:
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Top Active Funds Outperform Indices, Manage Risk

In the 19 years from 2000–2018, a range inclusive of two recessionary periods, Active Funds delivered higher average annual total returns than their Passive Fund counterparts across all five asset classes examined.

Shown in TABLE 2, the asset class in which Active Funds outperformed by the largest margin was International Equity, where Active Funds’ returns beat the Passive Fund by 2.99 points. The smallest gap in performance was in Emerging Markets funds, where the Active Funds average annual total return was just 83 basis points higher than that of the Passive Fund; however, the Emerging Markets Active Funds average total return was 11.1%, the highest of any asset class or active/passive strategy included in this study.

Across all asset classes, the Active Funds’ average annual total return was 1.89 pts higher than their Passive counterparts (TABLE 2).

While the average Active Fund in our study outperformed the Passive Fund in each asset class, there were certainly funds whose returns fell below the benchmark. The logical next question is, “How difficult is it to actually pick one of the funds whose returns are above average?” TABLE 3 shows that, depending on the asset class in question, 53–64% of Active Funds outperformed the Passive Funds from 2000–2018.

TABLE 3 also shows a run of poor performance for Active Funds in the US Equity class. The Passive Fund for US Equities, SPDR ® S&P 500 ETF (SPY), has outperformed more than 50% of Active Funds in seven of the ten years following the financial crisis, from 2009–2018. The historically long bull market in US Equities, which covers the same time period, has made it hard for active managers to keep up, as evidenced by Active Funds’ recent and consistent underperformance.

On the topic of consistency, Active Funds do add value beyond returns metrics. TABLE 4 compares Active and Passive Funds on both risk and return metrics, highlighting how Active Funds can offer better risk-adjusted returns and less volatility. Across the four equity asset classes studied, Active Funds delivered higher total returns, higher risk-adjusted returns, lower standard deviations, and lower 30-day max drawdowns than the Passive Funds against which they are benchmarked.

With regard to Fixed Income, Active Funds beat the Passive Fund on performance (total returns) and risk-adjusted returns (Sharpe Ratio); however, the Fixed Income Passive Fund, Vanguard’s Total Bond Market Index (VBMFX), clearly stood out as offering lower standard deviation and 30-day drawdown when compared to the average Active Fund.

The “Right” Active Fund Yields 10x-30x Returns

In the previous section, we showed that selecting at random from the Active Funds in this study gives an investor a slightly greater than 50% chance of outperforming the Passive Fund in each asset class. So, if your investment selection process were not random — if it were so sophisticated that you were able to predict which would be the best performing Active Fund each year — by how much would you outperform the benchmark?

This exercise, the “Crystal Ball Scenario,” illustrates that correctly identifying a winning Active Fund would deliver substantial market outperformance; this is something a Passive Fund, by nature, could never do.

As shown in TABLE 5, a $10,000 investment in the International Equity Passive Fund, Vanguard’s Total Intl Stock Index (VGTSX), on January 1, 2000, would grow to just under $17,000 by the end of 2018. The same $10,000 investment in the best-performing International Equity Active Fund, and rolled into each year’s best Active Fund, would be valued at more than $570,000 by the end of 2018, an ending value nearly 34 times that of the Passive Fund.

Even in Fixed Income, the asset class with the smallest Best Active Fund-Passive Fund spread, investing in the Best Active Fund each year would yield an ending value more than six times the Passive Fund.

Conversely, there is a chance that in your pursuit of the “best,” you instead invest in the worst-performing Active Fund each year. If you managed to select the worst US Equity Active Fund 19 years in a row, your initial $10,000 would end at $6,060, a 39% loss.

Without possessing an actual crystal ball, the “Crystal Ball Scenario” would be difficult to achieve. In another hypothetical requiring virtually no research, the “Returns Chasing Scenario,” we asked, “How would a $10,000 investment fare if, at the beginning of each year, you invested in the previous year’s best-performing fund?”

In the US Equity asset class, the Returns Chasing Scenario grew from $10,000 to just over $45,000 in the 19 years from 2000–2018, a 1.85x returns multiple when compared to the US Equity Passive Fund SPY.

Even with a rudimentary strategy such as the Returns Chasing Scenario above, Active Funds can still add alpha.


An investor’s need for active or passive strategies is dependent on his or her investing goals. While those seeking a low-maintenance strategy would be well served by index-tracking ETFs like those Passive Funds included in this study, Passive Funds will never beat the market, and amid downturns, Passive Funds are inadequate to provide protection. For investors wanting risk protection and a chance at outperformance, pursuing Active Funds could be the answer.

We asked, “With the continuing rise in popularity of passive funds and the flow of investors’ money into indexing strategies, is there an argument to be made for active management?”

While the strategies to locate and take advantage of Alpha vary, investors can find the outperformance and risk controls that top Active Funds provide. Some strategies, like that in the “Crystal Ball Scenario,” are nearly impossible; and others still, like the “Returns Chasing Scenario” are illogically basic.

Even as funds flow out of Active and into Passive Funds, and still fairly many Active Funds fail to outperform the benchmarks against which they are measured, alpha is available for the taking.

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