An overwhelming body of academic research demonstrates that the past performance of actively managed mutual funds does not provide valuable information as to future performance. For example, Eugene Fama and Kenneth French, authors of the 2010 study “Luck Versus Skill in the Cross-Section of Mutual Fund Returns,” found that fewer active managers (about 2%) were able to outperform their three-factor (beta, size, and value) model benchmark than would be expected by chance.
However, believers in active management were offered hope with the 2009 study by Martijn Cremers and Antti Petajisto, “How Active Is Your Fund Manager: A New Measure That Predicts Performance,” published in The Review of Financial Studies. The authors concluded: “Active share predicts fund performance: Funds with the highest active share significantly outperform their benchmarks, both before and after expenses, and they exhibit strong performance persistence.”
Active share is a measure of how much a fund’s holdings deviate from its benchmark index, and funds with the highest active share tend to have the best performance. Thus, while there’s no doubt that, in aggregate, active management underperforms and the majority of active funds underperform every year (and the percentage that underperform increases with the time horizon studied), if an investor were able to identify the few future winners by using active share as a measure, active management could be the winning strategy.
This raises an interesting question: Has the secular shift toward passive investing – index funds and exchange-traded funds have grown from about 19% to over 50% of equity fund assets since 2010 – changed how active funds perform, and if so, through what mechanism? Hannah Unterberg attempts to answer that question in her June 2026 paper “Passive Flows, Active Woes: Passive Investing and the Decline of Active Mutual Fund Alpha.”
What the paper examines
Unterberg studied US domestic-equity mutual funds and ETFs from 1984 to 2024, using CRSP fund data merged with Thomson Reuters holdings data. She found that active performance has deteriorated sharply as the relationship between active share and performance didn’t just weaken after 2010 – it flipped entirely. Her explanation is a flow-driven mechanism: When investors pull money from active funds and into index funds, the active managers are forced to sell down their existing (often concentrated, off-benchmark) positions, while passive inflows buy mechanically in benchmark weightings regardless of price. This creates lopsided demand – selling pressure on stocks that active managers like, buying pressure on stocks they don’t hold – and that pressure shows up directly in fund returns.
Key findings
1. Active fund alpha roughly doubled in its underperformance after 2010. Using the Carhart four-factor model, average net alpha for active funds fell from negative 0.72% annually (1984–2009) to negative 1.82% annually (2010-24).
2. The active-share premium reversed. Before 2010, high-active-share funds beat low-active-share funds by 0.85% annually (gross, four-factor). After 2010, high-active-share funds underperformed low-active-share funds by 1.11% annually.
3. Flow-induced demand explains the reversal. Unterberg finds:
- Before 2010, active share positively predicted future flow-induced demand: Active funds benefited from flows.
- After 2010, active share negatively predicts flow-induced demand: The more a fund deviates from its benchmark, the more adverse flow pressure it faces.
- When flow-induced demand is added as a control in return regressions, the negative active-share coefficient becomes statistically insignificant. In other words, controlling for flow pressure largely explains away the post-2010 active-share underperformance. Manager skill has not deteriorated, market structure is the cause of the decline.
Investor takeaways
Active share is no longer a reliable positive signal. A measure that was a useful predictor of outperformance through the 2000s now correlates with underperformance in the current environment. Investors and advisors who are still using active share as a simple screen for skilled managers should be aware that the historical relationship has not just weakened, it has reversed.
This is a story about demand mechanics, not eroding manager skill. That distinction matters for how investors interpret active fund track records. Underperformance driven by structural flow pressure is a different phenomenon than underperformance driven by managers losing their edge – and it has different implications for whether skilled stock-picking still has value once the flow headwind subsides or reverses.
Implications for market efficiency
Unterberg’s findings suggest capital reallocation toward passive vehicles is large enough, and the supply of price-elastic capital willing to absorb it is limited enough, that flows themselves move relative prices in economically meaningful and persistent ways. That has a few implications worth sitting with.
1. Price discovery may be getting less efficient at the margin for stocks where active and passive ownership diverge most. If the buying/selling pressure described here doesn’t fully arbitrage away over a three-year horizon, prices for some securities are, at least temporarily, being set as much by mechanical flow as by anyone’s assessment of fundamental value.
2. It complicates simple “passive investing makes markets more efficient because it pushes out unskilled active managers” narratives. The paper directly tests and rejects the idea that a shrinking active sector should mechanically improve the performance – and by extension, the price discovery quality – of the managers who remain. The source of the contraction matters: Managers exiting on account of flow-driven redemptions face a different competitive landscape than managers exiting because of genuine underperformance.
Unterberg’s paper offers a useful reframing of the question: Why did the historical edge associated with high active share evaporate – and reverse – just as passive investing became the dominant force in equity markets? The answer she provides isn’t that “active managers got worse.” It’s that the market’s plumbing changed. Reallocation from active to passive funds creates structural, asymmetric demand that disproportionately penalizes exactly the kind of benchmark-deviating bets that used to define skilled active management.
Concluding thoughts
For evidence-based investors, this is a reminder that performance predictors aren’t static laws of nature – they’re conditional on market structure, and that structure has shifted meaningfully over the past 15 years. It’s also a useful caution against treating “passive investing makes markets more efficient” as an unconditional truth. The mechanism documented here suggests that, at least for the segment of the market most exposed to active-to-passive flow rotation, the opposite may currently be true.
Larry Swedroe is a freelance writer and author. The views expressed here are the author’s. For informational and educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. The author does not own shares in any of the securities mentioned in this article.
This article was first published by Morningstar.com, and has been edited for Firstlinks.