Short-Term Active Fund Outperformance Is Often Random

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Advisors should avoid chasing actively-managed ETFs and mutual funds based on short-term outperformance, according to a new study from research firm Morningstar. 

The study, which examined roughly 9,000 mutual funds and ETFs from 2021 through 2024, found that by year two, the majority had fallen out of the top quartile of funds in their categories.

Advisors have been increasing their allocations to ETFs in recent years, and more of their money is going toward active ETFs, according to recent data from Escalent. Escalent found that, currently, 80% of advisors have allocations to active ETFs, and their share of active ETF assets rose from 25% in 2024 to 29% in 2025. Advisors pointed to factors like access to a wider range of markets and strategies, as well as greater liquidity and transparency, as some of the reasons for their heightened interest.

Morningstar examined fund performance in both the active and passive categories and found that passive funds tended to stay in the middle of their categories over periods spanning 10 to 15 years, offering a more reliable, but average, performance in the long term.

However, when it came to actively managed ETFs and mutual funds that landed in the top quartile of their category for a year or two, their outperformance appeared largely random, according to Dan Sotiroff, senior analyst, passive strategies, North America, at Morningstar, and one of the study’s authors. Sotiroff and his co-author, Eugene Gorbatikov, analyst, passive strategies, EMEA, looked at total returns plus price appreciation as a measure of the funds’ performance. 

The takeaway for financial advisors is “Don’t be anchoring to short-term past performance whenever you are selecting funds,” said Sotiroff. “You have to get over what a fund did over the past year or two. Anchor to the things that are going to give you much more of a long-term success rate—low fees, the quality of the management team, the reliability of the strategy over a long period of time.”

To measure how consistently the study’s funds outperformed, Morningstar identified top-quartile funds in their categories starting in 2021 and tracked their positioning over one, two, and three-year periods. By 2024, out of the 20 categories included in the actively managed bucket, all funds in 11 categories had fallen out of the top quartile.

Actively-managed fund categories that showed slightly greater performance stickiness over a three-year period included intermediate core bond (six out of the initial 35 funds remaining), foreign large blend (four out of the initial 49 funds remaining), small blend (three out of 44 funds remaining) and small value (three out of 31 funds remaining).

The greater consistency in those categories likely has to do with the strategies themselves, which might offer more opportunities for skilled managers to improve performance, according to Sotiroff. 

“It was in the fixed-income categories, in particular, where we noticed that,” Sotiroff said. “It’s very different than the equity world. There are a lot of things that active managers can do to improve the funds’ performance that indexes just don’t have available to them.”

Another takeaway from the study is that actively-managed mutual funds and ETFs with higher fees tend to underperform their low-fee counterparts. The probability of staying in the top quartile for performance in their category is about 6% higher for cheaper funds. At the same time, expensive funds with a short-term poor performance had a 13% higher chance of remaining in the bottom quartile or undergoing a merger/liquidation the following year.

“We do see a higher rate of those bottom performers shutting down eventually,” noted Sotiroff.

The study looked at about 9,000 funds with roughly $24 trillion in combined assets. It left out funds of funds and funds with less than $10 million in AUM.