It's been a rough few years for active investment management – that is, an investment manager making decisions about which investments to buy or sell. Across most major markets, more than half of active equity funds have lagged their benchmarks. That raises a fair question: why bother with active strategies at all, when you could just buy the index for less?
The short answer is that the reasons for underperformance are mostly about market conditions, not a lack of manager skill. There's a clear pattern in the data: wherever a small number of giant companies have driven index returns, active managers with diversified portfolios have struggled to keep up. But wherever markets have been less lopsided, or less efficiently priced – e.g. smaller companies, emerging markets (until very recently), listed infrastructure, and bonds – active managers have generally held their own, and often done better than the index. That pattern matters, because it points to conditions that shift over time rather than a permanent decline in manager skill.
Why have active managers struggled?
A few things have combined to make life hard for active managers:
- A handful of huge companies have driven most index returns. Active funds are usually restricted, by design and by client requirements, from putting 20–30% of their money into just a few stocks, the way a market-weighted index effectively does. So, when a small number of giant companies drive most of the market's return, a manager has to be right about exactly those names, in roughly that weighting, just to match the benchmark – let alone beat it.
- Fewer stocks have been "in the rally." How many companies are actually participating in a market's gains has been unusually thin, especially among large companies. When only a handful of stocks are doing the work, there's less room for good stock-picking to add value. History shows this tends to widen out again after periods of market turmoil, as happened after 1999–2000.
- Interest rates and economic conditions have been unpredictable. Shifting inflation, unconventional central bank policy, heavy government spending, and heightened geopolitical risk have repeatedly wrong-footed active positioning in both shares and bonds – even in cases where a manager's.
- The pain hasn't been even across the board. It started specifically in large-cap Australian and global shares, where index concentration has been most extreme, then spread to other asset and sub-asset classes (emerging markets, listed property). Active bond managers, by contrast, have held up better throughout.
What does this mean for investors?
- This kind of market isn't normal, and it won't last forever. Index leadership this narrow is historically unusual, not the norm. Markets this top-heavy tend to broaden out again over the course of a cycle. When that happens, the conditions that have punished diversified stock-pickers usually ease, and the gap between the best and worst performing stocks – the very thing active management depends on – tends to widen again with it.
- "Active vs passive" is too simple a debate. It depends heavily on the asset class, region, and market segment. Active managers have generally done better in bonds, smaller companies, and less efficient markets than in large, concentrated share indices. Blanket statements about "active vs passive" obscure those real and persistent differences. A well-built multi-asset portfolio should use both tools, depending on where each is best suited and portfolio requirements / settings.
- Averages don't tell the whole story. Industry statistics on active performance are measured at the category level, not for any individual manager. That hides a lot of variation between managers. A rigorous, well-governed process for researching and selecting managers – with clear criteria for when to buy, retain, sell, or remove a fund, and genuine ongoing monitoring – is what actually identifies the funds likely to justify their fees, rather than just accepting the category average.
- Passive investing hasn't delivered on all its promises. It was sold on three promises: it's cheap, it's diverse, and it's liquid. Today, only the first one really holds up well. It's still cheap. Liquidity mostly still holds too, though in some markets, including Australia, even large, well-known shares have become harder to trade in size than they used to be. The diversity benefit has been the most eroded: as index funds have become more concentrated in a small group of giant companies and sectors, active strategies are now arguably more diversified than passive ones!
- Active managers can manage risk in ways passive can't. Passive strategies deliver market exposure, which is valuable, but that also means they deliver market downturns in full force, with no cushioning. In an environment of heightened geopolitical risk, inflation volatility, interest rate uncertainty, technological disruption, and shifting demographics, many investors need more than just market exposure. They need active risk management: downside protection, the ability to shift between sectors, and portfolios tailored to their specific goals, liabilities, or tax situation.
- Conditions may be turning in active managers' favour. After years of passive dominance, the backdrop is shifting. Higher interest rates tend to restore the value of fundamental, company-by-company investing. The AI boom is creating a growing gap between clear winners and losers within sectors. And structural shifts like regulatory change, deglobalisation, and the energy transition are creating new inefficiencies for patient, research-driven investors to exploit. History shows active management has tended to shine after periods of concentration and complacency like the one markets have just been through.
The bottom line
Active management was never about winning all the time. The case for it is that, in the right segments, backed by rigorous manager selection and judged over a full market cycle rather than a difficult stretch, it can still earn its place in a well-constructed portfolio.
Active management has struggled because markets are competitive, and many strategies haven't delivered on their promise recently. But it isn't dead. Human judgement, specialised knowledge, and active risk management still matter in a complex, ever-changing world – and the conditions that have made the last few years so hard are, by their nature, unlikely to persist indefinitely.
The Investment & Research team at PSK are always monitoring market conditions and data points to ensure portfolios align with our overall long-term objectives. If you’d like to discuss any of the points raised, please contact your Adviser or call us on (02) 8365 8300.
