A new report from Morningstar tells a traditional story: actively managed funds underperform over the short and long-term, especially high-cost actively managed funds.

The third edition of the Morningstar Active/Passive Barometer, first issued last June, compared the investment returns and survival rates of actively managed mutual funds and ETFs to their index fund counterparts in multiple investment categories over one, three, five and 10 years. Only among diversified emerging market funds did the active funds outperform the passive.

Close to two-thirds of the active diversified EM funds outperformed their passive counterparts over the one- and three-year periods ended June 30, and just over 50% outperformed over five years. Longer term their success rates lagged overall – less than one-third of these funds outperformed — but it was a different story for the cheapest among them.

More than 60% of the lowest cost actively managed diversified emerging market funds outperformed their index fund counterparts over the 10-year period, while less than 12% of the highest cost funds in that category did.

“Fees matter,” according to the Morningstar report. “They are one of the only reliable predictors of success.” Investors improve their odds of success “by favoring inexpensive funds, as evidenced by the higher – than average success ratios of the lowest-cost funds across most categories,” according to the report. Moreover, according to the report, investors reduce their odds of success when choosing among the highest cost actively managed funds. There are exceptions, however. Over the 10-years ended June 30, 2016, highest cost mid-cap blend and small-cap value funds outperformed their lowest cost counterparts.

Morningstar Active vs. Passive

Actively managed diversified emerging market funds also led in another analysis in the report. They, plus U.S. small blend funds, were the only actively managed fund categories whose performance improved year-over-year through June 30, 2016.

The performance of actively managed diversified emerging markets funds improved by almost 22%, while the performance of small-cap blend funds improved by 10%.

One of the key findings concerned the survival rates of actively managed funds over the long term. Just 55% of large-cap and small-cap actively managed funds survived over the 10 years ended June 30, 2016. Fees were an important variable here as well.

The lowest-cost funds among them tended to survive longer than the highest-cost funds. In the large-cap category, for example, 60% of the lowest cost actively managed funds survived over the 10-year period compared to just 46% of the highest cost funds.

Putting it altogether – longevity plus performance –  showed another surprising result. The so-called success rate for the trailing 10 years was highest among actively managed intermediate term bond funds, at 39%. The comparable rate for all major categories of actively managed stock funds ranged from 6.9% for U.S. mid-cap blend to 32.4% for diversified emerging markets funds.

But investors should not depend on the outperformance of the actively managed intermediate bond funds. Their one-year success rate  “has continued to experience significant deterioration … dating back to December 31, 2014,” according to the Morningstar report, which cites the “relatively greater credit exposure” of many actively managed funds in that category.

The takeway, according to Morningstar: “Most actively managed funds failed to survive and outperform their passive peers, especially, over the trailing 10-year period. The average dollar in passively managed funds typically outperformed the average dollar invested in actively managed funds.”

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