The team at AJ Bell have today released their latest Manager versus Machine report. And it paints an alarming picture for active managers, who are struggling to beat tracker funds on performance, and are losing hands down when it comes to fund flows.
A copy of AJ Bell’s full Manager vs Machine report can be found here.
Laith Khalaf, head of investment analysis at AJ Bell, comments:
“Active managers must be starting to feel like an endangered species. Not only is performance flagging, but passive funds are winning the battle for hearts, minds, and wallets. Retail investors have invested £37 billion into tracker funds since the start of 2022, while at the same time withdrawing a staggering £89 billion from active funds, based on AJ Bell analysis of Investment Association data. These are absolutely unprecedented outflows. It’s like a dark age has descended on the active management industry.
“Our latest Manager versus Machine report brings little succour for active managers. Just 35% of active managers have beaten a passive alternative over the last 10 years, down from 56% when we first launched the report in 2021. This isn’t entirely down to stock selection skill, or lack thereof, because some pretty stern headwinds have been battering active managers. Most notably the continued hegemony of big US technology stocks continues to pose existential questions for managers in the key Global and US equity sectors. Taking these sectors out of our analysis, a more respectable 46% of active equity funds have outperformed the passive machines.
“Things look even worse amongst insurance company pension funds, included in our analysis for the first time. Here, just 24% of active equity funds have outperformed a passive alternative over 10 years, with a particularly poor showing in the Global sector, where only 9% of funds outperformed. This is just one snapshot of the pension sector, but high charges for older products and widespread closet tracking could be partly responsible for the weak performance figures. Investors in pension funds are often disengaged, and the funds might be closed to new business, which adds little commercial pressure on providers to improve performance if it’s flagging.
“Of course, active pension funds investing in Global and US equities also face the challenge posed by a high concentration of technology stocks in passive portfolios. Some poor performance from the Magnificent Seven could be a real gamechanger for active funds, though as long as these tech titans go from strength to strength, it’s going to be increasingly difficult for active managers to compete with the passive machines.
“They say if you can’t beat them, join them. But then if active managers start mimicking indices with a large chunk of their portfolio, they lose their raison d’être, not to mention any sense of advantage over a plain vanilla tracker fund.”
Active versus passive fund performance compared
“Our latest Manager versus Machine report shows the market trends prevalent in 2023 have largely carried through into 2024, with relatively few active managers beating a passive alternative in the first half of this year. Just 35% of active equity funds in our sample achieved such a feat, and over 10 years the figure is actually the same; again just 35% of funds have beaten the passive machines.
Table 1. % of active funds outperforming a passive alternative
| YTD | 5 years | 10 years | 2023* | |
| Asia Pacific ex Japan | 62% | 36% | 52% | 38% |
| Europe ex UK | 36% | 43% | 45% | 39% |
| Global | 26% | 15% | 19% | 25% |
| Global Emerging Markets | 49% | 56% | 53% | 57% |
| Japan | 36% | 39% | 41% | 25% |
| North America | 35% | 21% | 22% | 40% |
| UK | 31% | 36% | 42% | 44% |
| TOTAL | 35% | 30% | 35% | 36% |
| Without US and Global | 42% | 42% | 46% | N/A |
Sources: AJ Bell and Morningstar, total return to 30 June 2024. *Data to 30 November 2023.
“Relative performance in the Global and US equity sectors has been deeply impacted by the concentrated nature of recent stock market returns. As Terry Smith points out in his latest letter to shareholders, just five companies were responsible for 46% of the returns of the S&P 500 index in the first six months of this year; Amazon, Apple, Meta, Microsoft and Nvidia, with Nvidia being responsible for 25% of the returns of the benchmark US index.
“Failure to hold a market weight in the top performing technology stocks has therefore been a costly enterprise for active managers this year, and indeed over the last decade. Coming into this year, an active US manager would have had to hold 28% in the Magnificent Seven stocks, and 7% in each of Apple and Microsoft, simply to match the exposure of a passive fund. Those are pretty punchy portfolio positions for an active manager to adopt, with the unpleasing result they would simply be in line with the rest of the market. Consequently that part of the portfolio would perform just like the benchmark, and would legitimately lead investors to question why they are paying active fees for the privilege of index returns.
“Thanks to strong performance from US tech stocks so far this year, concentration levels have become even more extreme. To match a passive fund’s exposure, an active US equity fund would now have to hold 32% in the Magnificent Seven stocks, with 7.2% in Microsoft, and 6.6% in each of Apple and Nvidia (as of 30 June 2024). The same trends impact global fund managers because the S&P 500 now makes up around 70% of global stock market capitalisation. Our Manager versus Machine H1 2023 report showed that the average active global equity fund held around 10% less in the US than a typical global index tracker.
strong performance in 2024 for all equity sectors
“Despite weak relative performance, Global and US active managers have provided investors with exceptionally high absolute returns. Although in the US only 35% have beaten a typical tracker so far this year, they have on average returned 13.9% in just six months alone (see Table 2). So while the figures in this report might suggest widespread disappointment, investors in these funds might actually be quite chipper. Indeed, absolute returns across all seven equity sectors in our sample have been warmly positive so far this year.
Table 2: Active fund performance YTD
| YTD total return % | ||||
| Active top quartile | Active average | Active bottom quartile | Average passive | |
| Asia Pacific ex Japan | 11.7 | 9.7 | 6.6 | 8.3 |
| Europe ex UK | 7.4 | 5.9 | 3.6 | 6.4 |
| Global | 12.7 | 9.1 | 5.8 | 12.6 |
| Global Emerging Markets | 10.1 | 8.0 | 4.8 | 8.2 |
| Japan | 8.1 | 5.8 | 2.5 | 7.1 |
| North America | 18.0 | 13.9 | 8.2 | 16.0 |
| UK | 8.4 | 6.6 | 4.7 | 8.0 |
Sources: AJ Bell and Morningstar, total return to 30 June 2024.
Dark times for the active management industry
“Fund flows tell quite a story about just how much pressure active managers are under. As Chart 1 shows, this has been an absolutely unprecedented spell of retail outflows for the active fund management industry. A small and not particularly reassuring glimmer of light at the end of the tunnel is that outflows appear to be slowing a touch. If the run rate for 2024 is maintained to the end of the year ‘only’ £31 billion can be expected to flee active funds, down from £38 billion last year. These are dark times indeed for the active management industry.
Chart 1. Net Retail Sales
Source: Investment Association
Some historical context
“The previous iterations of Manager versus Machine also provide some context for the current weak showing from active managers. When we first pitted active managers against the passive machines in 2021, 56% of active managers outperformed a passive alternative over a 10 year period. Across all sectors active performance has weakened since then, with the exception of the North American equity sector, which stands at the same low level it did three years ago (see Chart 2). The variation suggests there is some cyclicality in the performance of active managers, and we may be witnessing a downdraft driven by the longstanding hegemony of US technology stocks, which serves to push active managers further into a deep black hole the longer it persists.
Chart 2. % of active funds outperforming over 10 years
Sources: AJ Bell and Morningstar, total return to 30 June 2024.
PASSIVE FUND CHOICES
“It’s important to recognise passive funds themselves are not one homogenous lump, even within individual equity sectors, as Table 3 shows. Passive investing therefore still requires some active decisions to be made, both in terms of the sector and specific fund chosen.
Table 3. Passive fund return dispersion
| 10 year total return passive funds % | |||
| Max | Average | Min | |
| Asia Pacific ex Japan | 128.0 | 103.4 | 80.7 |
| Europe ex UK | 125.8 | 123.7 | 121.7 |
| Global | 315.3 | 226.6 | 195.5 |
| Global Emerging Markets | 82.6 | 73.3 | 70.4 |
| Japan | 132.6 | 129.4 | 125.1 |
| North America | 339.1 | 329.1 | 310.1 |
| UK | 81.1 | 75.8 | 47.1 |
Sources: AJ Bell and Morningstar, total return to 30 June 2024.
“There are two main factors which explain the dispersion of passive fund performance. One is the index selected to be followed. This is by no means uniform within each equity sector, for instance in the Global sector, where over 10 years the S&P Global 100 index has trounced the MSCI World Index to the tune of over 80 percentage points.
“The other factor is charges. For two funds tracking the same index, the difference in return can largely be laid at the door of charges. Hence in the UK why one fund tracking the FTSE 100 has turned £10,000 into £17,940 over the last decade, and another following precisely the same index has turned that same sum into just £16,400. The former charges just 0.06% per annum, the latter 1.06%. Table 4 shows the spread of passive fund charges in each sector. Seeing as these funds usually perform very similar jobs, investors holding expensive tracker funds can achieve better long-term returns by simply switching to a cheaper competitor.
Table 4. Spread of passive charges June 2024
| Passive funds ongoing charge % | |||||
| Most expensive | Average | Cheapest | Range | ||
| Asia Pacific ex Japan | 0.30 | 0.16 | 0.11 | 0.19 | |
| Europe ex UK | 0.13 | 0.11 | 0.05 | 0.08 | |
| Global | 0.54 | 0.14 | 0.12 | 0.42 | |
| Global Emerging Markets | 0.39 | 0.24 | 0.20 | 0.19 | |
| Japan | 0.29 | 0.15 | 0.08 | 0.21 | |
| North America | 0.30 | 0.10 | 0.05 | 0.25 | |
| UK | 1.06 | 0.16 | 0.05 | 1.01 | |
Sources: AJ Bell and Morningstar, total return to 30 June 2024.
Pensions are investments too
“We have also added pension funds into our analysis for the first time in this edition of Manager versus Machine. Insurance company pension funds receive very little attention and yet contain hundreds of billions of pounds, and their performance dictates the retirement prospects of millions of people. Our analysis of active pension funds suggests even fewer have beaten a passive alternative than standard, non-pension funds over the last 10 years. Just 24% of pension funds have outperformed the average passive fund, with a particularly poor showing in the global sector where only 9% of active funds beat a passive alternative.
Table 6. % of active pension funds outperforming a passive alternative over 10 years
| % of active funds outperforming over 10 years | ||
| Pension funds | Standard funds | |
| Asia Pacific ex Japan | 54% | 52% |
| Europe ex UK | 41% | 45% |
| Global | 9% | 19% |
| Global Emerging Markets | 41% | 53% |
| Japan | 37% | 41% |
| North America | 14% | 22% |
| UK | 20% | 42% |
| TOTAL | 24% | 35% |
Sources: AJ Bell and Morningstar, total return to 30 June 2024.
SUMMARY
“Active funds continue to feel the pressure on both performance and flows. Current market trends have been in place for a long time and aren’t helping. While new flows are going predominantly into passive funds, they still only make up 24% of total fund assets reported by Investment Association members. No doubt there will come a saturation point, but it doesn’t feel like we’re there yet. Many investors want a cheap and simple home for their money, and passive funds fit the bill. Over the last 20 years DIY investors have proliferated beyond hobbyists with lots of less experienced investors joining the fray. Meanwhile advisers have also sought the sanctuary of tracker funds which don’t open them up to complaints from clients if things don’t go to plan. The passive genie is very much out of the bottle.
“It’s worth noting this report only covers seven equity sectors, and there are areas where passive strategies are less common, or more complex, and where active management can still lay claim to some higher ground, for instance funds targeting income, low volatility or investing in smaller companies. We should also acknowledge that the market return itself is partly a function of active managers collectively allocating capital, and all market participants, including passive funds, benefit from that. The more investment that flows into passive funds, the more money is allocated to companies purely based on their size, and while that has been a winning trade for the last 10 years, it won’t strike most people as a failsafe way to pick win
