One of the best years this century for US fund outperformance

US funds gave a better overall showing than usual in 2022, according to a widely followed report that keeps tabs on the performance of professional investors.

Volatile markets, which we experienced in 2022, in theory give active fund managers greater ability to add value as they can make changes to portfolios to protect capital. In contrast, the performance of index funds and exchange-traded funds (ETF) is dictated by how the stock market performs.

• Invest with ii: Open a Stocks & Shares ISA | ISA Investment Ideas | Transfer a Stocks & Shares ISA

In 2022, nearly one in two US large-cap active funds outperformed, which, according to S&P Dow Jones’ latest active versus passive scorecard, is among the highest result of any year this century. Only in 2005, 2007, and 2009 did such funds fare slightly better.

While there’s plenty of debate over the merits and flaws of active and passive funds, one thing that both camps agree on is that the S&P 500 index is notoriously difficult for US fund managers to consistently beat, given that it is the most widely researched and followed index.

However, in 2022 a total of 49% of US large-cap funds outperformed the S&P 500 index, which declined by 18% in total return terms. This marks a big improvement on 2021 when only 15% of such funds outperformed.

As the report points out, there’s a coin-flip chance that investors picked a US large-cap fund that beat the S&P 500. But it did acknowledge that “declining markets can make active management skill more valuable”.

Two US fund categories in which most active managers outperformed a comparable index were small-cap core and small-cap value.

• Seven easy ways to find an active fund worth its salt 
• ISA fund ideas for different ages and stages 
• How many funds should I own in my stocks and shares ISA? 

The index provider, however, cautioned against “celebrations in the active investment community”, highlighting three reasons.

“First, because it was still close to a 50-50 split and marginally in favour of the benchmark,” it said.

“Second, because, even including 2022’s relatively benign performances, the vast majority of actively managed funds nonetheless underperformed over periods of 10 years or more.

“And finally, because although the challenges to outperformance diminished in 2022, it was an unusual year and active outperformance might well be harder to attain in the future.”

Over 10 years the data shows that in most US fund sectors only around 5% to 10% outperform.

A separate recent active versus passive fund study by Morningstar detailed performance for various other countries. For the UK, it found that 48% of UK equity income funds outperformed in 2022. The other two UK sectors examined fared less well, with outperformance of 21.7% and 21.4% for UK large-cap equity and UK mid-cap equity respectively.

Morningstar notes that 2022 was “the type of environment where active managers could have been expected to beat passive peers more easily, as these typically incorporate the full downside in market valuations”.

However, on average Morningstar found that only 29% of active funds outperformed their passive peer in the one-year period to the end of December 2022.