Passive v active investing: Performance scorecard

Research shows relatively few active managers are able to outperform passive managers. Find out what gives index funds the edge.
By · 1 May 2024
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1 May 2024 · 5 min read
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For a long time, managed funds in Australia paid attractive upfront and trailing commissions to those advisors who recommended them to investors. Perhaps partly because of this, managed funds became broadly used investment vehicles in Australia. You may ask, and why not? Having professional fund managers manage your money should be a great way to invest. Except it seems that's not always the case.

The most recent SPIVA Australia Scorecard shows that a significant 85% of Australian share funds failed to match the average market return over the 15 years to 31 December 2023. Global share funds fared even worse with 94% failing to match the average global market return over that same period. 

What is the SPIVA Scorecard?

The SPIVA Australia Scorecard is said to serve as the "de facto scorekeeper of the active versus passive debate". It measures the performance of actively managed funds relative to benchmarks (indices) over various time horizons. 

The performance of Australian equity funds, for example, is measured against S&P/ASX 200 while the S&P Developed Ex-Australia LargeMidCap Index is used for international equity funds.

It's worth noting that indices are largely investable. So, you could invest in an ASX200 index ETF, for example, that will provide you with a similar return to the index, less the fees charged for managing the fund (which are generally quite low).

SPIVA Australia Scorecard 2023 results

The latest results show little evidence that active fund managers earn the fees that they charge. In the category of Australian shares, 77% of managed funds underperformed the index over one year, rising to 85% underperforming over 15 years. 

Look at global shares and the rate of underperformance is even higher, with 81% of funds trailing the average market return over one year, rising to 94% trailing through both 10 years and 15 years. 

The data on one-year returns for global shares, however, provides some food for thought. On average, international equity funds returned 19.2% in the calendar year of 2023, according to the SPIVA report. What's not to like about a 19.2% return over 12 months? Well, the average market return was 24.1%, meaning an investor in an index-style investment was 4.9% better off over the year, less the costs of the index fund (likely around 0.2%). The lesson? Even in a period of great returns, it is worth comparing how your investments are performing against the market. 

There are some areas where the underperformance was not as widespread. Active bond managers, for example, had a good year - 74% outperformed the index over 12 months. The report found that the longer-term record of bond funds "was also better relative to other categories, with 56% and 46% underperforming over the three- and five-year periods, respectively".

The majority (64%) of actively managed Australian Equity Mid- and Small-Cap funds also beat the benchmark over one year but the same can't be said over the longer term. More than three-quarters (77%) are lagging over 10 years.  

Why actively managed funds underperform

Let's look at the four main reasons that actively managed funds underperform and why index funds have the edge.

1. Information is everywhere 

Benjamin Graham is one of the renowned teachers of investment theory, with his pupils including Warren Buffett, and is reported to have said shortly before his death in 1976, "I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago......I doubt whether such extensive efforts will generate sufficiently superior selections to justify their cost."  

The enormous body of information about each listed company, supported by rules requiring 'continuous disclosure' from companies, means that it is hard for any investor - individual or professional - to find information that they can use to help them generate an above-average return. The media, brokers, specialist research companies, academics and the companies themselves are providing so much information that there seem to be almost no profitable secrets left. 

2. Fees 

Quite often in investing, fees are hidden behind percentages. A 1.5% fee does not seem especially high, however, it can have a material impact on the returns of a managed fund. 

Over the 10 years to the end of February 2024 the S&P/ASX 300 had provided an average return of 7.93% a year. When you consider a 1.5% annual fee in that context, suddenly you have given away nearly 20% of the returns in fees. 

Here's an example: $10,000 earning an average return of 7.93%p.a. would be valued at $21,449 after 10 years. 

If you take out 1.5% in fees, reducing the return to 6.43%, the $10,000 only grows to $18,648 over 10 years. That is an 'underperformance' of about $2,800, or 28% based on the initial $10,000. 

The fee of 1.5% makes a difference. The fund manager in question has to, over 10 years, invest in companies that provide a significantly better return (to the tune of 28%), or the investor will be behind the average market return. 

Fees for index funds and ETFs tend to be significantly lower. 

3. Looking like the index, with higher fees 

Most fund managers manage large amounts of money, with limits as to how much they can put into any one company. That effectively makes them start to look like an index fund - they are forced to put more money into large companies, and less into small ones. When they look like an index fund but charge much higher fees, they are very likely to underperform. 

The following table looks at the portfolios of two Australian share funds and considers the similarity between their top 10 holdings and the top 10 holdings of the overall market. 

Top 10 holdings: ASX 300 v Colonial First State and Perpetual Australian Share funds

S&P/ASX 3001

Colonial First State
Australian Share Fund2

Perpetual Australian
Share Fund1

BHP (9.44%)

BHP (11.04%)

BHP (9.3%)

CBA (8.26%)

CSL (7.07%)

CBA (7.1%)

CSL (5.86%)

CBA (6.2%)

 Flutter Ent (5.5%)

National Bank (4.49%)

NAB (5.26%)

NAB (4.9%)

Westpac (3.92%)

RIO (4.15%)

Goodman (4.5%)

ANZ (3.62%)

ANZ (3.54%)

Origin (4.4%)

Wesfarmers (3.2%)

Woodside (2.98%)

CSL (4.4%)

Macquarie (2.97%)

Westpac (2.66%)

IAG (4.3%)

Woodside (2.44%)

Aristocrat (2.6%)

La Francaise (4.3%)

Goodman Group (2.19%)

Goodman Group (2.43%)

Westpac (3.9%)

1 At 29 February 2024. 2 At 31 January 2024.

Both the Colonial First State and Perpetual funds have underperformed the index over 10 years. The Perpetual Australian Share Fund's 10-year return to the end of February was 1.49% per annum below the index return - although the fund had outperformed over three and four years. 

The Colonial First State Australian Share Fund had lagged the average market return by 1.33% per annum over the 10 years to the end of January. 

4. Trading and 'market impact costs' 

As a managed fund investor, you can be 'punished' with poor performance for the trading that comes from other people's decisions to add or withdraw money from the managed fund. As other investors buy or sell their holdings, the fund manager has to buy or sell extra shares. This can have a significant cost because managed funds trade in such large quantities that they can push market prices against themselves. 

If a managed fund wants to sell a significant holding in a small company, it can end up pushing the price of the shares down because they are selling a large holding. The opposite is true for buying, and these 'market impact costs' can reduce fund performance. 

It can also increase the level of capital gains distributed to investors at the end of the financial year. 

Key takeaways

The 2023 SPIVA Australia Scorecard shows the tendency of managed funds to underperform the average market return and is consistent with other reports showing similar data. High fees, the need for frequent trading, a tendency to have portfolios that look like the index and the difficulty in finding unique information to support superior share selection combine to provide a challenge that few funds seem to be able to overcome with performance above the average market return. 


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Scott Francis
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