AJ Bell Active v Passive Report 2021

•    Only a third of active equity funds (34%) beat a passive alternative this year, according to our latest Manager versus Machine report
•    Active outperformance was particularly sparse in the US, Global, and Asia Pacific regions
•    Longer term figures suggest active managers have on average beaten the passive machines across most sectors
•    But in the crucial US and Global sectors, passive funds have won the last decade hands down, and these sectors now account for £270 billion of investors’ money
•    Why active managers have done well in the UK
•    Active v passive charges by sector
•    Best and worst performing funds this year

Laith Khalaf, head of investment analysis at AJ Bell, comments:

“2021 has been a pretty grim year for active managers, with passive funds ruling the roost and delivering better returns for investors on average. Outperforming active funds were particularly sparse in the Global and North America sectors, which are hugely important for investors because they are two of the most popular areas for investment, accounting for £270 billion of investors’ money.

“In the North America sector, fewer than one in five active funds outperformed a passive alternative in 2021, and the picture is not much improved when looking over a ten-year period. Longer term underperformance from active funds in these sectors suggest there is a structural reason why relatively few funds outperform a passive alternative. This is no doubt partly down to the fact the US stock market is poured over by so many analytical eyes and so active managers naturally find it more difficult to find an edge. But the continued market domination by a small number of large tech stocks may also be feeding into the equation, reinforcing the implicit passive principle that big is beautiful, and punishing those who take a dissenting view with their portfolios.

“This issue has increasingly affected the Global sector too, seeing as the US stock market has grown to such an extent that it now makes up around two thirds of the world index. Global tracker funds therefore increasingly resemble US tracker funds, making it more difficult for active funds to compete in this arena while the US maintains its ascendancy. If the raging US bull market comes a cropper though, this performance differential could get turned on its head, seeing as the average global active fund is around 8% underweight the US compared to passive peers.

“As ever, averages and aggregate data can’t tell the whole story, and individual investors do have the opportunity to improve their own lot through fund selection, both active and passive. For active investors this means picking seasoned fund managers who have proved their performance potential, or their ability to deliver a set outcome such as a high level of income or a low level of volatility, though of course there can never be a cast iron guarantee of future performance. 

“For passive investors, fund selection entails picking funds that track appropriate market indices effectively, at the lowest price possible, as charges will be a key determinant of returns. In the UK sector in particular, there is still an awful lot of money invested in tracker funds that are nowhere near the competitive end of pricing, in some cases charging ten or twenty times more than the cheapest fund on the market, year in, year out. Over a lengthy period, those higher charges are going to eat into passive investors’ wealth.

“Many investors of course choose to mix and match passive with active strategies, and our performance analysis suggests where each strategy might be in its element. In particular, within the Global and US sectors, active funds have failed to bring home the bacon compared to index funds. That’s by no means true of all active funds and there are some leading lights of the fund management world with offerings in these areas, for example Baillie Gifford and Fundsmith.

“While the long-term performance numbers from the US and Global sectors look pretty damning for active investors as a whole, it’s worth bearing in mind that market performance in the last ten years has been heavily influenced by ultra-loose monetary policy and the digitalisation of the global economy. Should one, or both, of those trends moderate or even go into reverse, life might not prove so breezy for the passive machines that simply invest money according to the size of companies in the market.”

Manager versus machine in numbers

The table below shows the percentage of active funds that have beaten the average passive fund in the seven popular equity sectors across three time periods.

Active fund performance is often compared to that of a benchmark index, but our Manager versus Machine report uses passive funds as a yardstick instead, because in the real world, investors don’t have the option of buying the index, they can only gain exposure through trackers. The figures therefore indicate whether it’s been better to be an active or index investor in each sector.

	% of active funds outperforming passive
IA sector	2021 YTD	5 year	10 year
Asia Pacific Ex Japan	26%	44%	63%
Europe Ex UK	53%	46%	64%
Global	25%	40%	30%
Global Emerging Markets	50%	63%	72%
Japan	47%	61%	64%
North America	19%	32%	22%
UK	41%	71%	85%
TOTAL	34%	51%	56%

Sources: AJ Bell, Morningstar, total return in GBP to 01/12/2021

Tech domination tightens

“Active performance in the US and Global sectors has been particularly disappointing, but that may partly be down to the increasingly concentrated nature of the S&P 500, because the US stock market itself has become increasingly dominated by a small cluster of tech names. These tech titans are now the seven biggest companies in the US market, and by extension in the global market. While not all have prospered over 2021, as a group they have tightened their grip on the US stock market. Together they make up 27% of the S&P 500, up from 24% at the beginning of 2021. 

“US active managers find themselves between a rock and a hard place when it comes to participating in the hegemony of the tech titans. In order to have an overweight position in these stocks, an active manager running a US fund would have to allocate over 27% of their portfolio to these seven companies. That’s a pretty punchy active position to be imposed on a fund manager purely by market leadership. Even if an active manager were to hold the 27% to maintain a market weighting in these stocks, that’s over a quarter of their portfolio that’s simply pegged to the market, which would actually be losing ground against a comparative tracker fund because of the higher charges associated with an active approach. On the other hand, any US active manager who had dared not to hold any of these stocks over the course of 2021, would have found themselves facing some uncomfortable questions around performance.

“The increasing concentration of large parts of the global stock market capitalisation in a limited number of companies operating in technology driven industries should be cause for concern for active and passive investors alike. The melt up in the US market has relied heavily on exceptionally strong performance from these few large tech stocks. Given their heavy weighting in US and global indices, a turnaround in fortunes for a relatively small number of companies could therefore inflict significant damage on the global stock market as a whole.”

	S&P 500 tracker weight %
	2nd Dec 2021	31st Dec 2020	2021 YTD share price growth
APPLE INC	6.6	6.7	24.2
MICROSOFT CORP	6.4	5.3	48.4
ALPHABET	4.3	3.3	61.7
AMAZON COM INC	3.9	4.4	5.7
TESLA INC	2.3	1.7	55.2
NVIDIA CORP	2.1	1.0	141
META PLATFORMS	1.9	2.1	13.7
Total	27.3	24.4	N/A
S&P 500	N/A	N/A	23.3

Sources: AJ Bell, SharePad, iShares.com

Longer term performance

“While the wide-ranging underperformance of active managers in 2021 tells us something about market conditions over the course of the year, such a short period of time can’t tell us too much about the long-term value of active management. Even for a skilful active manager, the question of performance over the course of a year would be little more than a coin toss. Looking over the longer term, active managers have done a better job than in 2021, though outperformance has still been scarce in the US and Global sectors. There is some survivorship bias in the numbers too, and while in theory this might apply to both passive and active funds, in reality it’s much more likely to positively skew returns in the active segment and can be expected to exert greater upward pressure on the performance figures the longer the time period under inspection. 

“The fact that over 10 years only 56% of active funds have beaten a passive alternative, despite a tailwind from survivorship bias, demonstrates that investors need to be picky when it comes to buying active funds, and perhaps the regions in which they choose to allocate to active managers. Around a third of the funds in our 2021 sample sit in the Global sector, reflecting its popularity amongst investors, and that means the fortunes of funds in this sector have a disproportionate effect on the picture for active and passive funds taken as a whole. Active funds in other sectors have fared considerably better though.

“Overall, it’s clear that Global and US sectors have been the place to be over the last ten years, and investors in underperforming active funds might take some consolation from the fact that simply allocating to these sectors has likely been more important in generating returns from fund selection in other areas.”

IA sector	2021 average performance %		5 year average performance %				10 year average performance %
	Active	Passive		Active	Passive	Active		Passive
Asia Pacific Ex Japan	1.4	5.6		58.3	59.9	166.0		142.8
Europe Ex UK	13.2	12.9	64.6		69.7	201.5		185.2
Global	15.5	19.5		78.3	85.1	240.5		277.4
Global Emerging Markets	0.6	0.5		53.4	48.4	115.0		90.8
Japan	1.9	2.5		49.9	40.0	169.8		155.6
North America	22.9	26.6		99.9	114.6	353.4		404.1
UK All Companies	12.9	13.8		38.9	29.3	134.0		95.6

Sources: AJ Bell, Morningstar, total return in GBP to 01/12/2021

Active managers have prospered in the UK

“The UK has been a particularly good home for active managers, with the average active fund returning 134% compared to 95.6% from the average passive fund over 10 years, a significant differential that cannot easily be explained by survivorship bias alone. There are some other factors in this sector which can go some way to revealing why active managers have performed so well against passive alternatives though.

“The IA UK All Companies sector is home to a significant number of funds which focus on the midcap area of the stock market. Indeed, of the ten best performing UK funds over ten years, four explicitly target the FTSE 250 as their benchmark index, and many of the other top performing funds have a multi-cap approach which sees them invest heavily in small and mid-cap companies. Not only have small and mid-caps significantly outperformed the big blue chips over the last ten years, they are also a fertile hunting ground for active managers to pick out hidden gems, as they are not as well scrutinised by the wider market. The positive midcap effect on the outperformance of active managers in the UK is also exacerbated by the fact that some passive funds track the blue chip FTSE 100 index, rather than the wider FTSE All Share.”

	Performance %
	2021 YTD	5 year	10 year
FTSE 100	14.8	28.8	91.0
FTSE 250	13.9	48.2	191.2
FTSE Small Cap	19.6	70.6	249.2

Sources: AJ Bell, Morningstar, total return in GBP to 01/12/2021

“The UK All Companies sector is also one of the oldest, and that has some bearing on the passive funds that are available in this area too, with some higher charging legacy funds helping to lower returns across these funds as a whole. Whereas the cheapest UK tracker fund in the sector costs just 0.05% per annum, there are a number of funds which cost over 1%. When looking at performance for both active and passive funds, we have used median instead of mean averages in order to mitigate the effect of outliers like this within the data sets. However, inevitably there will still be some downward performance pressure from higher charging passive funds in the UK, compared to a sector like the US, where the lowest fund charge is also 0.05%, but the highest is a much more competitive 0.29% per annum.

“While the effect of mid cap performance and higher charging tracker funds do tilt the balance in favour of active funds in the UK, these factors are still present in the UK fund investment universe, and so are a fair representation of the investment opportunity set open to investors in UK funds.”

Active v passive fund charges compared

“Looking at annual charges more broadly, on average UK active funds are typically offered at a lower price than most other regions and command a smaller premium over passive alternatives too. Combined with strong relative performance from active managers in the UK, this suggests that if investors do wish to invest some of their portfolio actively, the UK is a favourable place to do it.

“Charges on the most competitively price tracker funds have come down significantly in the last ten years, and so discriminating passive investors can expect to improve their lot by shopping around. Active fund charges have also become more competitive since the Retail Distribution Review prompted greater transparency in this market. Active funds are less commoditised than passive funds though, with managers competing not just on charges, but also on performance and volatility. Active investors may legitimately therefore choose to pay a price premium for a fund manager they have a high level of conviction in. Such considerations don’t carry much weight in tracker land, where index selection and price are the key components of investment decisions.”

IA sector	Average ongoing charges %
	Active	Passive	Active premium
Asia Pacific Ex Japan	0.95	0.15	0.80
Europe Ex UK	0.89	0.12	0.77
Global	0.92	0.2	0.72
Global Emerging Markets	1.01	0.25	0.76
Japan	0.9	0.13	0.77
North America	0.86	0.1	0.76
UK All Companies	0.86	0.17	0.69

Sources: AJ Bell, Morningstar

Best and worst performing funds year to date

The table below shows the five best and five worst performing active funds in each sector in the sample over the course of 2021 to date.

	YTD total return %		YTD total return %
IA Asia Pacific Ex Japan		IA Europe Ex-UK
Matthews Asia Small Companies	27.0	BlackRock Continental European	24.9
JOHCM Asia ex-Japan Small & Mid-Cap	21.2	MI Chelverton European Select	23.2
Fidelity Asian Smaller Companies	16.8	MFS Meridian Continental European Equity	21.1
Barings ASEAN Frontiers	16.0	Liontrust European Growth	20.2
Aberdeen Standard Asian Smller Companies	14.0	FTF Martin Currie European Unconstrained	19.9
Templeton Asian Growth	-6.4	VT Downing European Unconstrained Income	5.6
Ninety One Asia Pacific Franchise	-6.7	Schroder European Alpha Plus	5.5
FTF Martin Currie Asia Unconstrained	-7.4	Man GLG European Alpha Income	4.6
Legg Mason MC Asia Long Term Unconstrained	-7.7	BMO Select European Equity	2.2
Janus Henderson Asia Pac Capital Growth	-8.7	VT Argonaut European Alpha	1.5
IA Global		IA Global Emerging Markets
Equitile Resilience Feeder	31.1	Carmignac Pf Emerging Discovery	23.7
Denker Global Financial	28.9	Templeton Emerging Markets Smaller Companies	23.6
CCM Intelligent Wealth	26.9	FP Carmignac Emerging Discovery	22.1
MI Thornbridge Global Opportunities	26.8	Aberdeen Standard EM Smaller Companies	16.9
Montanaro Global Innovation	26.8	Artemis SmartGARP Global EM Equity	13.4
WS Charteris Global Macro	-1.7	MI Somerset Global EM Markets Screened	-9.2
Lindsell Train Global Equity	-2.2	Wells Fargo WF EM Equity	-9.4
Invesco Global Consumer Trends	-2.8	MI Somerset Global Emerging Markets	-9.5
Pictet Human	-10.4	FP Carmignac Emerging Markets	-12.5
Baillie Gifford Global Discovery	-16.0	Carmignac Pf Emergents	-12.8
IA Japan		IA North America
Man GLG Japan Core Alpha	16.0	VT De Lisle America	34.1
M&G Japan	13.7	Schroder QEP US Core	30.8
GS Japan Equity Partners	13.6	Royal London US Growth	29.0
Pictet-Japanese Equity Selection	13.0	Allianz Best Styles US Equity	28.5
LF Morant Wright Nippon Yield	9.4	JPM US Select Equity Plus A	27.9
T. Rowe Price Jap Equity	-7.8	New Capital US Future Leaders	9.9
FTF Martin Currie Japan Equity	-9.5	Baillie Gifford American	9.6
Nomura Fds Japan High Conviction	-10.8	Wells Fargo WF US All Cap Growth	8.2
RWC Nissay Japan Focus	-15.7	Wellington US Dynamic Equity	7.2
Lindsell Train Japanese Equity	-19.3	Morgan Stanley US Advantage	5.5
IA UK All Companies
Artorius	31.6
Consistent Opportunities	29.9
Artemis SmartGARP UK Equity	27.3
VT Cape Wrath Focus	25.5
Allianz UK Listed Opportunities	24.7
M&G UK Select	4.2
Jupiter UK Mid Cap	2.3
Quilter Investors Equity	0.2
Baillie Gifford UK Equity Focus	-0.3
Baillie Gifford UK Equity Alpha	-2.1

Source: Morningstar total return in GBP to 01/12/2021

Manager versus machine methodology

Our report analyses the performance and charges of around 800 open-ended retail funds across seven popular equity sectors. Using funds identified as the primary share class, we calculate the number of active funds that have beaten the median performance of passive funds in the same sector, and also compare the median returns for active funds in each sector. Over longer time periods the performance data does contain some survivorship bias, particularly for active funds, because underperforming funds will have tended to have been closed or merged. We have also calculated the median charges for both active and passive funds across the seven equity sectors.