Latest Morningstar Report Makes the Case for Passive ETFs

The latest Morningstar Active/Passive Barometer report revealed that only 38 percent of active U.S. equity funds survived and outperformed their average passive counterparts in 2018, which represents a 9 percent drop from 2017. With the increasingly dismal performance by active funds, it argues the case for more investors to use exchange-traded funds (ETFs), particularly the passive variety.

According to data from XTF.com, the number of passive ETFs are over 1,100 compared to active, which comprises over 250. This availability of passive options makes the case for investors to seek ETFs compared to their mutual fund brethren, which are typically actively-managed and carry higher operation costs.

Additionally, with the growth-fueled momentum plays going the way of the dinosaur in this late market cycle, the report also serves as a reminder for investors to take a closer look at quality and value-based factors.

“Here’s even more evidence that the average investor is better served investing in ETFs,” said ETF Trends CEO Tom Lydon. “In addition, investors should pay more attention to quality and value factors as we’re in the later stages of this market cycle.”

Delving further into the report, the performance of active funds fell across 16 of 20 categories. Just 35 percent of active funds were able to beat passive funds in the respective categories.

Falling the hardest were active foreign stock funds, which have been barraged by trade wars and a strong U.S. dollar. Also feeling the pangs of market underperformance were active fixed-income funds as U.S. interest rates rose four times in 2018 while credit risk remains an ongoing concern as corporations are taking on more debt.

Speaking to the strong performance of the U.S. dollar given last year’s four rate hikes, the average active dollar ousted the average active fund–evidence that investors erred on the side of cheaper, but higher-quality funds.

Lower cost-funds were more successful about twice as often as their more expensive counterparts–a 32.5% success rate versus 17.2% success rate–over the 10-year period ended Dec. 31, 2018. Not only were these cheaper funds able to outperform costlier funds, but they had better longevity–about two-thirds of the cheaper funds survived versus half of the more expensive funds.

Other notable data points include actively-managed large cap funds having better success compared to active mid- and small-cap funds in the long term. The success rates of mid-cap funds were more widely-dispersed versus those of large- and small-cap funds.

Small-cap funds, however, had better survival rates compared to large- and mid-cap funds. 54 percent of active small-cap funds survived compared to 41 percent for large-cap and 53 percent for mid-cap.

To view the complete report, click here.

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