Mid-small active funds shine but most local stock funds lag again

Data shows most active fund managers underperform their benchmarks, so the average person is actually better off investing passively with index funds or ETFs.

Data shows 72 per cent of Australian small-mid cap active fund managers underperformed over 10 years and 58 per cent lagged over 15 years.

It’s an unfortunate fact that most active fund managers underperform their benchmarks.

The upshot is that retail investors really need to do their homework and not fall for marketing hype when looking to use an active fund manager to boost their investment returns.

For global stocks – the category where active managers have the worst track record in Australia – the sad reality is that 95 per cent of them will fail to beat their benchmarks over a 15-year period.

Some of Australia’s best known global active fund managers – Magellan and Platinum – beat their benchmarks for many years before eventually succumbing to misjudgment and key-man risk.

Unless a would-be investor is very confident about the track record and ongoing success of an active fund manager, they are far better to invest passively with index funds or exchange-traded funds.

As Warren Buffett would say: put 90 per cent of your money into a low-cost S&P 500 index fund and the other 10 per cent in short-term government bonds.

Thankfully most of Australia’s active mid-small capitalisation stock funds and bond funds often do have an edge over their benchmarks, in the short term at least. The theory is that there’s less research coverage of these categories versus large cap stocks and real estate investment trusts.

Investment doyen Warren Buffett’s view is 90 per cent of your money should be in a low-cost S&P 500 index fund and the rest in short-term government bonds. Picture: Getty Images

The moral of the story is that if you want to go down the active fund manager route, the first places to look, in Australia at least, should be mid-small cap stocks and bond funds.

But even there, most fail to beat their benchmarks in time frames longer than five years.

The SPIVA Australia Scorecard measures the performance of actively managed funds relative to benchmarks over various time horizons, encompassing equity, real estate and bond funds, while providing statistics on outperformance rates, survivorship rates and fund performance dispersion.

It shows that for the 2024 calendar year, 63 per cent of actively managed Australian equity mid-small cap funds outperformed the S&P/ASX mid-small index. Funds in the category achieved an asset-weighted average return of 14.5 per cent before fees versus a 10.5 per cent from the S&P/ASX mid-small total return index.

In the Australian bonds category, 70 per cent of active ­managers beat their benchmark in 2024.

They delivered an asset-weighted average return of 3.9 per cent, compared to a 2.9 per cent return for the S&P/ASX Australian Fixed Interest 0+ Index.

It was the second consecutive year of outperformance for both the Australian mid-small cap stocks and Australian bonds ­categories.

However, 72 per cent of Australian small-mid cap active fund managers underperformed over 10 years and 58 per cent lagged over 15 years.

S&P DJ notes that many more years of strong performances will also be needed to change the longer-term statistics for active Australian bond funds as 82 per cent lagged over the 15-year ­period.

The rest of the report makes for grim reading as usual, although the other categories haven’t been quite as bad in recent years as they have been over the longer-term horizons.

In the global equity category, 85 per cent of active managers failed to match the benchmark’s return for the year, and a similar trend was observed in the Australian Equity A-REIT category.

In the global equity category, 85 per cent of active managers failed to match the benchmark’s return for the year.

Australia Equity General funds fared relatively better, with a 56 per cent underperformance rate. In active Australian equity A-REIT funds, where the benchmark posted a robust 18.5 per cent return, the underperformance rate of 86 per cent was the highest of all categories for the year.

This category also exhibited the lowest “survivorship”, as nine out of 51 funds either merged or liquidated during the year.

Over the 15-year period, 87 per cent of them underperformed.

For the Australian stockmarket last year, S&P DJ notes that the weighting of the top 20 stocks in the S&P/ASX 200 remained elevated, at 63 per cent, by the end of 2024.

This presented challenges for the Australian large-cap active equity managers seeking opportunities outside of the stocks most heavily weighted in the capitalisation-weighted ASX 200.

Global equity active funds faced more significant headwinds, as an unusually high 72 per cent of constituents in the S&P World index underperformed the index last year.

In Australia, a high but not as extreme 60 per cent of ASX 200 constituents underper­formed.

S&P DJ notes that when fewer stocks outperform, it becomes increasingly difficult for managers to identify them, so in this context, it is perhaps not surprising to observe a higher-than-average underperformance rate among global equity general funds in 2024.

For mid-small equity active funds the admirable active performance in 2024 may have been enabled by a greater opportunity set, as indicated by elevated levels of dispersion in the benchmark.

In 2024, the average monthly dispersion of the S&P/ASX mid-small was 32 per cent versus 22 per cent for the ASX 200.

Higher index dispersion also accompanied a wider distribution of fund returns in the Australian mid-small-cap category versus the Australian equity general category.

Meanwhile, bond managers may have benefited from more favourable market conditions for active management globally, continuing a trend identified in the SPIVA Global Scorecard at mid-2024.

In Australia, rates remained elevated at the front end of the curve and lower at the back end for a considerable period, which allowed for the harvesting of higher yields with less duration risk.

Credit spreads also narrowed, with the S&P/ASX corporate bond 0-5 year index generating a 1.7 per cent excess return versus the S&P/ASX government bond 0-5 year index for the year, implying that managers who had taken on more credit risk were ­rewarded.

Historically, Australian bonds funds tended to have lower ­underperformance rates during years when lower-credit ­corporate bonds outperformed government issues, the S&P DJ said.

Originally published as Mid-small active funds shine but most local stock funds lag again