Many active managers have disappointed in recent years. As a result, some investors now believe that “going passive” provides a safe harbor from underperformance and perceived risks of active management. Hence, passive investing continues to gain market share at a rapid pace.
However, this might not be the right time to make an active decision to go passive.
Empirical evidence shows that results from active management tend to be cyclical: out-of-favor periods followed by strong performance reversals.
The late '90s was a challenging period for active managers. Conversely, from 2000 through 2010, more than 50% of active managers in the eVestment U.S. large cap universe outperformed the Russell 1000 index, on a rolling three-year basis.
More recently, since 2011, more than half of the active U.S. large-cap managers in this same eVestment universe have underperformed the Russell 1000 on a rolling three-year basis — a striking resemblance to the late '90s.
In addition to cyclicality, performance by active managers often tends to be influenced by the direction and magnitude of market performance. History shows that active managers tend to do better in moderately up or down markets and underperform in strongly up markets.
For example, from Dec. 31, 1994, to Dec. 31, 2014, the median U.S. large-cap equity manager outperformed the Russell 1000, in all annualized rolling three-year periods, when the absolute performance of the Russell 1000 was less than 11.1%. Similar results can also be observed in global markets, when the median global large-cap equity manager outperformed the MSCI World index, in all annualized rolling three-year periods, when the absolute performance for the index was less than 12.2%. As of the end of 2014, the annualized three-year return for the Russell 1000 index was a whopping 20.6%, and the annualized three-year return for the MSCI World index was 16.1%. Historically it has been very difficult for active managers to outperform in a strong market environment. (Performance quoted is gross of fees based on the eVestment database.)