Over the trailing decade, the gross returns on actively managed large-company U.S. stock funds, before paying official fund expenses but after accounting for trading costs, have been competitive with those of index funds, says John Rekenthaler, vice president for research at Morningstar, in a recent online opinion piece. The problem for active funds, he adds, is not tied to their investment decisions but to management fees and, to a lesser extent, taxes their strategies incur.

But how will these active funds fare if trends of the past two decades continue? A review of 20 years’ worth of data by Morningstar’s head of global manager research, Jeff Ptak, used rolling seven-year time periods and compared active category totals to investment-style indexes through late 2014; while a different study done by Rekenthaler ran through November 2015.

“Happily, though, they [tell] the same general story: Among the three large-company categories, active large-value managers had higher gross returns than the index in both studies. Active managements’ gross returns for the other two categories hovered around those of the indexes,” the Morningstar columnist said.

Taking a closer look at Ptak’s 10-year figures for large-company stock funds vs. those of 15 and 20 years, the research shows that active management’s results for large-value funds have improved. However, they have “slumped for the other two categories of blue-chip U.S. stock funds,” Rekenthaler adds.

Over 20 years, relative gross returns for active large-blend funds were positive. Furthermore, the outperformance by active large-growth funds made them “fully competitive with index funds even after expenses,” he explains.

Gross returns for six mid- and small-cap categories “stomped those of the comparison indexes for 20 years, with an average annual victory of more than 100 basis points for mid-cap funds, and 250 points for small-company funds,” the Morningstar research manager says.

However, Rekenthaler points out, the victory margin “has shrunk over the more recent decade, such that only active small-value funds have been able to beat the indexes after paying expenses.”

The Conundrum

It’s worth considering the fact that a popular index may not be a “perfect match” for a fund’s Morningstar category. Some large-company U.S. stock funds, for instance, “dabble in smaller fare and thus have a smaller-company tilt than either the S&P 500 or even the Wilshire 5000,” according to the Morningstar research specialist. “This makes active large-company managers look smart when the broad market thrives and dumb when the bluest of chips lead the way.”

Still, this benchmark mismatching probably only has “a minor effect,” he shares, and likely does not impact the majority of the Morningstar style box categories (with only the large-value category being a modest exception to the pattern).

These days, most investors know about indexing, so nearly all assets move into passive funds or a “handful of the top active funds,” Rekenthaler states. In other words, it can be argued that the sales success of index funds has led to “the better performance of index funds.”

Overall, he notes, a number of active mutual fund managers were concerned about a possible tech bubble in the 1990s and were underweight technology, moderately, as the rally progressed. As a result, they were in a good place when the bear arrived.

In addition, the relative performance of active large-value managers has “actually improved, rather than declined, over the most recent decade, and the slippage for the mid- and small-cap value categories has been modest,” Rekenthaler argues. “This supports the tech-stock theory, as neither value funds nor value indexes ever had much technology, suggesting that their results would be relatively unaffected by the events of 2000–02.

While there is “something to the competition theory,” he says, even more persuasive is the argument that active management could not repeat its relative success from 2000 to 2002 when the next stock-market crash hit in 2008.

“That failure continues to penalize its relative performance, as well as the perception of the marketplace. If active stock-fund management is to thrive, and to make a strong case for itself against indexing, it must outperform during the major bear markets,” Rekenthaler concluded.