Advisors and investors alike hear all the time in various articles, speeches and interviews that passive investment funds (indexes) always outperform active investment funds (non-indexes). In my view, however, I’ve found that most articles written on the subject rarely provide precise “apples to apples” comparisons, much less an all-institutional dialogue about true data.
Therefore, through a series of articles, my hope is to provide a simpler yet more precise view of the landscape on this argument from an institutional investment outlook, as it excludes all the highly loaded fee structured products. To keep the data as objective as possible, I’m using Morningstar Direct as my source of screening, testing and research on return/expense data points.
In this first article, I’m only analyzing the asset class space of mutual funds within the U.S. Large Cap Blend investment arena. My points of fund screening include the following:
- Morningstar Category = Large Blend
- Equity/Style Box (Long) = Large Blend
- Investment Area = United States of America
- Fund Inception Date = < 12/31/1999 (For a true picture of a 15-year return period comparison, since anything shorter than 10 years, I believe, can easily be misinterpreted.)
- Fund Share Class = Institutional Only
The results of the data search provided a total of 79 mutual funds. My data-points screening below indicates that of those 79 funds, 30 are Index Funds and six are Enhanced Index Funds, leaving 43 actively managed funds:
- Indexed Funds = Yes or No
- Enhanced Indexed Fund = Yes or No
- Total Return Annualized 5 years trailing (Month End 3/31/15)
- Total Return Annualized 10 years trailing (Month End 3/31/15)
- Total Return Annualized 15 years trailing (Month End 3/31/15)
To further clarify, I think it’s important to define a few data points above. First, Morningstar defines its Total Return Annualized as a return net of any management, administrative and 12b-1 fees and other costs taken out of the fund’s assets, and doesn’t include sales loads or redemption fees. Of course, institutional share class funds generally have no sales loads; so I think we can assume the 5-, 10- and 15-year returns analyzed to be a true total NET return.
Second, Morningstar defines Enhanced Index Funds as funds similar to index funds, which attempt to match an index’s performance, but are unlike index funds since they attempt to better the index by either adding value or reducing volatility through selective stock picking. In other words, they’re really a mixed structure of indexing and active management.
The following chart examines how well the passive/mixed versus active funds argument pans out for the Institutional U.S. Large Cap Blend space:
In conclusion, the data seems to show that in the last five-year bull market, indexing has performed slightly better than active. However, once we move to a 10-year lookback, the data seem to be on a more even keel between passive versus active, with active winning in the 10-year and 15-year returns by a wider margin.