Morningstar Research Says Passive Still Hard To Beat

Morningstar Research Says Passive Still Hard To Beat

Also, ETFs have arrived, and the history of the thematic fund space is probably not what you thought it was.

Reviewed by: Heather Bell
Edited by: Heather Bell

Morningstar’s Passive Research Showcase, which took place Monday at the company’s 2022 investment conference, contained few surprises, at least at the beginning. It delved into the age-old active debate before shifting to cover fund flows and the state of the thematic fund market from a global standpoint. 

Director of Global ETF Research Ben Johnson kicked off the session, drawing parallels between the Morningstar Active Passive Barometer and the S&P Index Versus Active Scorecard but noted that the Morningstar model compares funds to an equal-weighted average of the peer index funds in a particular asset class. SPIVA, on the other hand, compares funds to a single index from the S&P lineup that represents the asset class.  

“This reflects the fact that there's more than one investable version of that benchmark available to investors in any particular category, and that they're not free. They're not frictionless; there are costs involved in accessing those underlying indexes,” Johnson said. 

“And what you can see here is that across the 20 or so Morningstar categories that we include in our regular analysis, most funds failed to survive and failed to outperform their average index peer. In fact, if you look back to calendar 2021, less than half of actively managed funds included in the study managed that feat,” he added. A PowerPoint presentation noted that only 45% of actively managed funds outperformed their passive peer benchmark in 2021.  

But Johnson also notes that short-term performance contains more noise than signal, while longer-term performance is more about the signal.  

“That signal that's clear is that long-term success rates are really quite low. If you take, for example, the U.S. large blend category, you go back 20 years, from the end of 2021, less than 10% of active U.S. large blend funds managed to outperform their average indexed peer. The other signal that comes through loud and clear in this analysis is that long-term success rates are generally higher among the least costly funds,” he noted.  

Johnson described the probability of outperformance in the U.S. blend category over a 10-year look-back period as “not great,” and the payout profiles as “atrocious.” 

“Not only were your odds slim when it comes to picking a winning manager in this category, the potential payout just wasn't there,” he said, adding that the outcomes varied across categories. 

Johnson advised investors to focus on fees, because lower-cost funds have better odds to survive and thrive, and to “pick your spot,” noting that emerging market categories tend to have more opportunities and that investors should spend their active risk budget wisely. 

Flows Show ETFs Have Arrived 

Morningstar Research Analyst Ryan Jackson then took the stage to discuss where investor dollars were heading. The first section of his presentation was “ETFs Have Arrived,” and he provided copious data to support the premise.  

Jackson pointed out that ETFs represent 27% of the total U.S. fund market as of the end of April, having grown from just 3% in 2007. Total assets under management have grown 15-fold in 15 years.  

“ETFs collected $4.7 trillion over the past two decades; that was nearly double the same haul for open-ended funds in that same time horizon,” he said, noting ETFs really hit their stride in the mid-2010s. 

But Jackson described 2020 and 2021 as a true inflection point, noting open-ended funds saw a $285 billion outflow as ETFs were pulling in $500 billion, while ETFs surpassed open-ended funds that year for the first time in terms of launches. In 2021, ETFs pulled in roughly $900 billion, about three times the flows of open-ended funds. 2022 seems to be more of the same, though Jackson noted flows numbers are expected to be somewhat milder. 

He attributes much of that asset growth to the range of choices now offered in the ETF wrapper, noting the products have seeped “into the different nooks and crannies of the market.” 

Even though they currently represent about 4% of the overall ETF market, active ETFs have been a big part of that proliferation since the passing of the ETF Rule in 2019, Jackson says. 

He highlights that inflation is a primary concern for investors, as TIPS ETFs pulled in $40 billion in 2020, representing organic growth of 66%, though the category has cooled off more recently. Now, fixed income investors are moving away from credit risk, turning away from high yield bonds in favor of things like intermediate government bonds.  

In particular, bank loan funds in 2021 saw their assets more than double, as investors were attracted by their ability to weather interest rate increases.  

“When you sum up bond ETF investors’ reduced appetite for credit and interest rate risk, what you get is a class of investors who are taking a very conservative approach to their bond ETF investments,” Jackson said, adding that investors have turned to ultrashort bond funds in more recent months. 

He notes the last decade has been rough for value stocks, while growth and value were fairly “neck and neck” in 2020. But it looks like value might be staging a comeback. 

“So far this year, value stocks have weathered the market volatility a lot better than their growth counterparts. When it comes to flows, even when value is posting dreary results, investors stood by their value bets,” Jackson said.  

Other trends he highlights are increased flows to non-U.S. categories such as emerging markets, as well as leveraged and inverse ETFs.  

“At the end of 2021, there were over 3,000 ETFs in the Morningstar database, and the top 100 of these constituted 69% of all ETF assets. It doesn't look like they're going anywhere anytime soon, as they collected about 46% of all inflows in 2021,” Jackson noted, but suggests that growth in those less popular areas could signal a change in the years to come.  

Thematic Funds Landscape 

Senior Analyst Kenneth Lamont closed out the showcase with a discussion of thematic funds. He notes the category didn’t start with the launch of Cathie Wood’s ARKK or metaverse ETFs but has been around much longer, citing a fund focused on the television industry that launched in 1948.  

Morningstar, according to Lamont, defines thematic funds as “funds that explicitly track one or more investment themes.” But it also includes sustainable funds capturing specific themes and active and passive funds under the “thematic” label.  

“When it comes to thematic funds, the difference between active and passive is much less pronounced than it might be elsewhere. Even with the most passive thematic funds, you're really taking a large active bet against the market,” he observed.  

In a graphic in his presentation, Morningstar’s taxonomy of thematic funds included those falling under the categories of technology, physical world, social and broad thematic. Another slide showing the growth of the thematic space demonstrated the space’s global nature, with Europe dominating the products available worldwide. 

Lamont notes that a decade ago, thematic funds comprised less than 1% of all equity funds, but currently represent close to 2%, having had a major spike in flows at the end of 2020. 

“Since the depths of the pandemic, thematic funds have been some of the best-performing funds,” he said, adding that there is increasing appeal of funds that disregard geographic, sector and size constraints, while data is improving, as is access to financial markets.  

“We like to say when investors are looking at this space that they’re making a trifecta or three-way bet,” Lamont noted, returning to his previous comment about the active nature of thematic investing. Not only must an investor identify a viable theme, they must select the right fund at the right time. 

In looking at survivorship, Lamont highlights that fewer than one in five ETFs out of all the U.S.-listed thematic funds that existed 15 years ago still exist, describing it as a “fairly aggressive attrition rate,” with most of the funds that closed never having “caught the imagination” of investors.  

“Your chances of picking a thematic fund that will survive and outperform over the long run is actually very, very low,” he said.  


Contact Heather Bell at [email protected] 

Heather Bell is a former managing editor of She has also held editorial positions at Dow Jones Indexes and Lehman Brothers. Bell is a graduate of Dartmouth college and resides in the Denver area with her two dogs.