“I have come to the realisation that I am not good at what I am doing.” This was the conclusion of Richard Toh, chief executive of Singapore-based hedge fund Kenrich Partners, reported by The Wall Street Journal after a year of chronic underperformance. After another year in which passive investment has outpaced active management, is it time for more active managers to admit that the game is up?
The latest Man versus Machine report from AJ Bell showed that only 31% of active managers have outperformed a passive alternative in 2024. That’s consistent with the pattern over the past decade, where about one third of active funds outperformed their passive equivalent.
Unsurprisingly, active managers have fared worst in the Global and North American sectors, where they have struggled to match the pace set by the technology giants.
The market environment of recent years has unseated some of the best and most respected active managers, particularly those with a ‘quality’ skew to their portfolios. In mid-2024, Nick Train, manager on the Finsbury Growth & Income trust, admitted after a tough set of results: “We really should be able to do better than this and if we can’t, then I absolutely share shareholders’ growing impatience.”
Performance has improved subsequently, but it has been a tough period. FundSmith Equity has also had a tough run of performance, underperforming the MSCI World Index for four calendar years in a row.
Active funds have also had to contend with significant outflows. AJ Bell points out that retail investors have withdrawn over £100bn from active funds in the last three years. Over the past decade trackers have gone from 10.5% of the UK market, to the current level of 24%, growing from £93bn to £359bn.
See also: Analysis: The key questions for asset allocators in the year ahead
Laith Khalaf, head of investment analysis at AJ Bell, said: “Active managers aren’t just suffering in terms of performance relative to their passive peers, they’re losing the battle for flows too. The last three years have witnessed an unprecedented rout for active managers in terms of fund flows.
“Since the beginning of 2022, £105bn has been withdrawn from active funds and £48bn has been invested in passive funds, based on AJ Bell analysis of Investment Association data. The exodus from active funds shows only the most minimal signs of abating, with 2024 withdrawals on course to come in just below those of last year’s record-breaking outflows.”
There have been brighter spots. In Global Emerging Markets funds, for example, 48% of managers have outperformed passive options over five years, with many active managers swerving the problems in China, while passive funds were forced to participate fully in its weakness.
Europe has been another relative bright spot, with 47% of active managers outpacing passives over five years. This may be because weak funds in Europe have not survived.
There is a question over how long this passive dominance can continue. If the US market is a guide, there may be further to run. in the US, the value of assets in passive funds overtook active funds for the first time last year, with more than 50% of the market now managed passively. Khalaf said: “It sets a meaningful roadmap of where the UK investment industry may end up. In other words, don’t bet the house on a revival in active management anytime soon.”
This is a depressing conclusion for active managers, but also for investing in general. It means that capital is allocated on the basis of size rather than merit and may see investment moving towards those parts of the market that need it least.
It may also be problematic for investors in the longer term. Dan Brocklebank, UK head at Orbis, said: “Global markets are increasingly concentrated in a few large, US-based companies. Investors in global tracker funds are thus becoming more dependent on the performance of a small number of companies.
“Similarly, many large active funds have high exposures to these same names, resulting in high correlations between the largest funds. This makes achieving true diversification difficult.”
What might change the dominance of passive? The most obvious trigger would be a wobble in the technology sector. The gloomy prognosis for active managers assumes that markets continue much as they have for the past decade.
There is no guarantee of that, particularly given the shift in the interest rate environment. History suggests that when markets hit this level of concentration, the reversal can be abrupt and uncomfortable. This may prompt investors to rethink their allocations to passive.
A better performance from smaller companies would certainly help active funds in certain markets. In the UK, for example, active managers tend to have higher allocations to small and mid-cap companies, and their weakness has been a persistent headwind. There are tentative signs of a shift in the outlook. UK-focused equity funds saw their first inflows in 42 months in the month after the budget, according to Calastone.
See also: CIOs name trade wars and concentration risk as 2025’s top concerns
Paul Marriage, manager of TM Tellworth UK Smaller Companies Fund at Premier Miton, said other factors could change the outlook for smaller companies in 2025.
“The chancellor’s Mansion House speech was a good opportunity to change the narrative post budget and her proposals to encourage UK equity investing are helpful, if lacking in detail,” said Marriage. “We expect the first long term asset funds (LTAFs) to start allocating to UK smaller companies in the first half of 2025. These are a very welcome new buyer to the market.” Buybacks and continued M&A could also support the sector.
ESG factors could be another consideration. Active managers are in a better position to ensure strong governance, challenge underperforming management teams, and hold companies to account on environmental or social risks. However, it remains unclear whether investors are willing to pay a premium for it.
Richard Toh is likely to remain an outlier, with most active managers holding out for a change in the unusual environment that has prevailed over the past decade rather than opting for a dramatic mea culpa. Nevertheless, for the time being, active managers remain under pressure.
