The conventional wisdom about active management holds that any value created by the decisions of fund managers is offset, or more than offset, by their fees. A review of the academic research published about the subject since 1997 found this conclusion to be “too negative on the value of the active management.”

Three primary findings underline the conventional wisdom about active management: the average fund underperforms after fees, outperformance is not persistent and few managers have skill in excess of costs. Several papers support the assertion of funds underperforming on a net-of-costs basis. The lack of persistence is attributed to research done in the 1990s, though ongoing analysis by S&P Dow Jones Indices supports the notion. The lack of persistence has been documented in more recent research and is blamed, in part, on increased competition.

There are research papers challenging the conventional notion. The usage of improper benchmarks can cause an actively managed fund to wrongly appear to underperform net of fees. Truly active funds—those whose portfolios differ significantly from their benchmark—outperform, while those with portfolios close to the benchmark (aka, closet indexers) underperform. Concentrated portfolios have tended to outperform.

Conclusions on stock-picking skills varied by study. Two studies published found evidence that funds select outperforming stocks, while another study found that outperformance related to this skill has declined over time. Two other studies found that the stocks with higher levels of mutual fund ownership outperform those with lower levels of mutual fund ownership.

The research discussed above pertains to equity funds. Research on mutual funds investing in most types of bonds were found to underperform on an after-fee basis. Research on environmental, social and governance (ESG) funds has mostly focused on the “potential negative impact” of restricting the choice of investments. The research on the outperformance of REIT (real estate investment trust) funds is mixed.

Source: “Challenging the Conventional Wisdom on Active Management: A Review of the Past 20 Years of Academic Literature on Actively Managed Mutual Funds;” K.J. Martijn Cremers, Jon A. Fulkerson and Timothy B. Riley; SSRN, September 11, 2018. This research was supported by the Investment Adviser Association’s Active Manager Council.