Active vs passive funds: the answer isn't as simple as the fees

Few debates in investing get as heated as active versus passive. One side says index funds win because they're cheap. The other says skilled managers can beat the market. The evidence is more interesting than either camp usually admits.

What the data says

S&P Dow Jones Indices publishes the SPIVA scorecards, which compare active funds against their benchmark indices. In US large-cap equities, the results over long periods are consistently tough on active managers. Over 10 to 15 years, a large majority of active funds have underperformed the S&P 500.

The reason isn't that fund managers lack skill. US large companies are among the most heavily researched assets in the world. It's very hard to know something the rest of the market doesn't, and higher fees make the hurdle even taller.

Where it gets less clear-cut

The picture varies by market. In some areas that are less efficient or less heavily covered, the share of active managers who outperform has historically been higher in certain periods. The results swing around a lot depending on the timeframe and region, which is exactly why it's worth looking at the evidence for the specific market rather than applying one rule everywhere.

There's another uncomfortable finding too. Funds that outperform in one period rarely keep doing it. SPIVA's persistence reports show that top-performing funds tend not to stay at the top, which makes picking tomorrow's winners from yesterday's league tables very difficult.

A practical way to think about it

For most people, the more useful questions are:

• What am I paying in total, including platform and fund charges?
• What market is this fund investing in, and how hard is it to beat that market?
• If I'm paying for active management, what exactly am I paying for, and how would I know if it's working?

Many portfolios end up as a blend: low-cost index funds for the core, with active funds used selectively where there's a reasoned case for them. Whatever the mix, understanding why each piece is there matters more than which label it carries.

Common questions

What is the SPIVA scorecard?

SPIVA is a set of reports published by S&P Dow Jones Indices that compares the performance of active funds against their benchmark indices across different markets and time periods.

Why do active funds struggle against the S&P 500?

US large companies are among the most heavily researched assets in the world, so it is very hard for a manager to know something the rest of the market doesn't. Higher fees raise the hurdle further.

Do funds that outperform keep outperforming?

Rarely. SPIVA's persistence reports show that top-performing funds tend not to stay at the top, which makes picking future winners from past league tables very difficult.