The study revealed that in certain areas, up to three-quarters of active funds failed to beat their benchmark over the past 10 years, begging the question why investors do not bypass the risk of underperformance and buy a tracker instead.
"Fund managers as a group have underperformed their benchmarks across most of the fund categories and time periods considered," said a spokesperson for the group.
The table below shows the percentage of funds that have failed to beat their benchmark over a number of different time horizons, as well as those that have had to close over the period.
Percentage of actively managed funds that underperform their benchmark
| Asset class | 5yr (%) | 10yr (%) | 15yr (%) |
|---|---|---|---|
| UK equity | 72 | 74 | 67 |
| European equity | 74 | 73 | 72 |
| Global equity | 74 | 64 | 76 |
| Emerging market equity | 82 | 87 | 93 |
| Diversified UK bonds | 91 | 100 | 94 |
| Global bonds | 58 | 73 | 100 |
Source: Vanguard
The results seem conclusive: over five, 10 and 15 years, more than 50 per cent of funds have underperformed their benchmark across all of the major equity and fixed interest sectors.
The most extreme results come over the longest time period, where in certain circumstances every actively managed fund in a set sector has underperformed its benchmark.
Vanguard points out that very few funds have a 15-year track record, which skews the results somewhat.
"The case for indexing over even longer horizons such as 15 years tends to be strong although, at this horizon, relatively few funds have been in existence for the entire period so the results are less reliable due to the smaller sample size," the spokesperson explained.
There can be no question marks over the scale over five years, however.
In the popular UK equity space, almost three-quarters of funds have either closed, or underperformed their benchmark – usually the FTSE All Share – over the five years to the end of 2012.
The figure is even higher for European, global and emerging market equity funds.
Even if the funds that have dropped out of the sectors are discounted, the majority have still consistently underperformed their benchmark.
For UK equity funds, the figure over five, 10 and 15 years averages out at 54 per cent. In global equity the average is 71 per cent, while in emerging markets it is 79 per cent.
Vanguard says the underperformance of actively managed funds is academic, as a result of the "zero-sum game" effect.
"The concept of a zero-sum game starts with the understanding that at any given point in time, the holdings of all investors in a particular market aggregate to form that market," the spokesperson said.
"Because all investors’ holdings are represented, if one investor’s positions outperform the aggregate market over a particular time period, another investor’s positions must underperform, such that the value-weighted performance of all investors sums to equal the performance of the market."
"However, once costs are taken into account, more funds will inevitably undershoot their desired benchmark than overshoot."
The study also points out that actively managed funds tend to be more volatile than their benchmark.
"While we have demonstrated the challenges with respect to outperformance, performance in terms of a lower expected return may not be the only negative outcome," the spokesperson continued.
"In each asset class [in the table], the median actively managed funds registered higher volatility and lower returns than the market benchmark, with the exception of diversified bond, where the volatility is very slightly lower than that of the benchmark."
"In other words, not only was performance poor, but investors experienced more risk to achieve that poor performance."
However, Rob Gleeson, head of research at FE, says that this data should not be taken at face value.
"Vanguard is treading a well-worn path with this research, and it is true that in aggregate over long time periods active funds don’t look like adding much, but there is more to this than meets the eye," he explained.
"The true benefit of active funds doesn’t come from enhanced returns but from the additional diversification benefits."
"The active process of stock selection lowers the fund’s correlation to the index, so even if an active fund individually doesn’t outperform, a portfolio of active funds can offer a much better risk/return profile due to the increased diversification benefits."
Gleeson also points out that if "closet trackers" – active funds that make only marginal calls against the benchmark – are excluded, the picture is likely to look quite different.
"I think it is important to distinguish between index-constrained funds and unconstrained active funds," he continued.
"Most indices are capitalisation-weighted, which isn’t necessarily the best way to build a portfolio."
"Unconstrained funds are free from this and have a massive advantage, even if the stockpicking can’t be relied upon to add much over the long-term."
Adam Laird (pictured), passive investment manager at Hargreaves Lansdown, agrees that investors should not dismiss actively managed funds just because the average ones underperform.
"This study is further evidence of an unfortunate truth – many active managers disappoint," he said. "There are some areas where it is very difficult for investors to find a good fund manager, such as US equity where many of the best funds are closed to new investment."
"Holding a tracker removes the risk that your fund will substantially disappoint – it should perform the same as the index, less charges."
"However, if you want to buy an actively managed fund, [it is possible to find] active fund managers who produce good, consistent returns."
Sceptics of passive funds also point out that the average tracker also underperforms its index thanks to the effect of charges.