Why do passive investments usually beat active ones?
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Actively Seeking Outperformance
The stated goal of an active investment style is to achieve a higher return than the benchmark index. This is done through regular, active adjustments to the weightings of individual securities, industries, sectors, or even entire countries and regions. This asset allocation is often determined by a whole team consisting of macroeconomists, analysts, and fund managers. They evaluate a variety of factors, from quantitative and qualitative data on individual securities to broader market and economic trends. Based on this information, the team buys and sells securities to exploit short-term price fluctuations. They then decide very specifically whether to buy pharmaceutical stocks rather than technology stocks on a given day or whether to replace Japanese stocks with Chinese ones.
Passive Investing and Mirroring the Market
The passive investment style aims for a return that is very close to the benchmark index. This is sometimes simply called the "market". There is no attempt to generate excess returns through individual bets. However, the passive investment style also does not run the risk of betting on the wrong horse and thus achieving a return that is significantly below the benchmark index.
Frequent trading and betting is not necessary, as the long-term trend in the financial markets is generally upwards anyway. As an investor, you therefore benefit from this fundamental upward trend in the long term.
The only difference between the index return and the return of the passive investment style is the management fee of the latter.
Mirroring the Market with ETFs
Since investors cannot simply "buy the market", a solution is needed that maps the desired index. And at a low cost. Exchange-traded funds (ETFs) do exactly that. This allows investors to invest broadly with just one investment. For example, an ETF on the Swiss stock market index represents the entire Swiss stock market.
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ETFs are Very Popular
Passive investing with low-cost ETFs is very popular. Meanwhile, more money is flowing into passive ETFs than into normal investment funds. Investments are even being withdrawn from actively managed equity and strategy funds and invested in ETFs instead, as figures from the fund data provider Lipper show.
Fee Comparison
An actively managed fund costs around 1.5% to 2% per year in management fees. In contrast, the passive ETF has an annual fee of around 0.25%. The active investment style must therefore achieve a return of at least 1.75% more than that of the passive ETF each year. And then the investor has not yet created any added value, but is only on par with an index-linked investment.
If we now compare the fees to the expected annual return (for this calculation example, we assume 6% per year, gross), then with the active investment style, around one third of the gross return is paid to the fund management, while with the passive style, it is less than one twentieth of the gross return.
Active Investment Style Hardly Successful in the Long Term
Achieving almost 2% excess return to cover the high management costs is something that only a few actively managed funds manage to do. Especially not on a regular basis. While the management fee is charged with beautiful regularity, the excess return lags far behind.
Looking at it over 1 year, the balance sheet still looks reasonably presentable, as every fourth actively managed equity fund delivers a better return than its passive counterpart. The main problem lies in the lack of consistency. In the long term, over 10 years, the balance sheet is then very sobering. A study by Morningstar found that 95 out of 100 active fund managers are not worth their money.
The data refers to the Morningstar category "Global Large-Cap Blend Equity" as of December 31, 2021.
Morningstar, the supplier of the data used above, therefore recommends "...focusing on fees...[because] compared to active funds, passive funds are generally much cheaper, which is why they are difficult to beat in the long term."
Conclusion:
The search for actively managed funds that consistently outperform the market over the long term is proving to be difficult to nearly impossible. 95 out of 100 active managers of global equity funds are not worth their money. ETFs as inexpensive and simple instruments are ideal for efficiently mapping a market. So that you don't have to worry about the best asset allocation, findependent offers 5 ready-made investment solutions to choose from. If you want to have a little more influence yourself, you can also choose from over 40 pre-selected ETFs and put together your own portfolio.
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