Is it a myth that actives add value in under researched markets?

Legal & General Investment Management’s indexation head Simon Midgen has added weight to the active-versus-passive debate. He says the received wisdom that active managers tend to outperform in less efficient and less researched markets – such as small-caps and emerging economies – is not correct.

Midgen, head of index funds strategy at the firm, cites S&P figures that suggest a majority of active managers have tended to underperform in these areas over the past 15 years.

For instance, in emerging markets 80% of funds underperformed, while in the same time period 84% of US small-cap active funds underperformed their indexes. Active underperformance also occurred in 58% funds studied in the European small-caps sector.

Overall, passive index returns beat active fund returns 87% of the time, and the average active fund underperforms its index by 2.6% annually.

Midgen said passive returns were bound to beat active due to simple mathematics.

“All stocks have to be owned by someone, and passive investors earn the market return, less low costs. Active investors also earn the market return less high costs – so in aggregate, passive investors will always earn higher net returns than active investors,” he said.

“It’s clear active management can be as ineffective in allegedly inefficient markets as it can be in efficient ones.”

Active managers generally argue that they can add value in markets that are less covered by broker research.

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