For many investors, a Ronco rotisserie chicken approach to stocks can make a lot of sense.
Buy an index fund; then set it and forget it. Why try to beat the market, after all, when active U.S. stock funds had another tough year in 2023—when only 47% of surviving funds beat their passive peers, according to new data from Morningstar.
But the data had an intriguing wrinkle: Active bond and real estate funds fared better than average. Nearly 53% of active fixed income funds outperformed passive funds in 2023, up from a 30% win rate in 2022. On the real estate side, 55% of active real estate funds topped indexes in 2023, up from 33% in 2022.
Winning funds last year in the bond space, according to Morningstar, included
Sterling Capital Long Duration Corporate Bond,
and
On the real estate side, top performers included
Commonwealth Real Estate Securities,
and
Third Avenue Real Estate Value.
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Why were active managers in bonds and real estate more successful? Part of it is structural—many large stock funds simply hug the S&P 500, failing to deviate enough to outperform after fees.
“It’s very easy for a stock index fund to just hold the S&P 500,” said Bryan Armour, director of passive strategies research for North America with Morningstar.
Packed with real-estate investment trusts, or REITS, the real estate sector tends to be less efficient, he points out. And real estate wasn’t nearly as crowded as the Magnificent 7 trade that dominated the S&P 500 last year. That makes it easier for active managers to find opportunities that investors might have ignored, Armour noted.
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Successful global real estate funds were able to beat their benchmarks by making outsized bets on U.S. real estate, which staged a bigger comeback than other markets last year.
The bond market is even more inefficient with securities trading over the counter, rather than on exchanges. Bond traders can capture gains on more mis-priced securities, though much of their outperformance typically comes from taking big swings on macro themes.
Broad positioning did the trick for many bond funds last year. Armour noted that many active managers fared better because they didn’t have as much exposure to government bonds as the Bloomberg US Aggregate Bond Index.
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“Active managers notoriously add a bit of credit risk compared to passive bond funds,” he said. “Passive funds will own more Treasuries than active peers.” As credit spreads tightened—fueling price gains for corporate bonds—active managers had an edge.
The longer-term success rate for active funds remains anemic. Morningstar said that less than 25% of all active funds survived and beat their passive counterparts over the past decade through December 2023.
“The trend towards passive investing is pretty firmly entrenched. Money managers have proven for a couple of decades that they aren’t beating the indexes enough to justify fees,” said Matthew Siegel, head of digital assets research at VanEck, which has a mix of passive and active funds.
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Some advisors use both active and passive index funds, though they point out that macro factors and the dominance of big tech in the S&P 500 are proving tough to overcome. “We pride ourselves on being active investors,” said Judith Lu, CEO of Blue Zone Wealth Advisors. “But it’s probably a better time for indexing today than a few years ago.”
Armour thinks active bond and real estate funds could have another strong year. “It does seem like this year looks more like 2023. So I would expect similar results for active fixed income and real estate funds,” he said.
There is no such thing as a Magnificent Seven in the bond world or REITs. If Big Tech falters, that could be a good thing for funds veering far from the herd.
Write to Paul R. La Monica at [email protected]
