Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 110

Why good active managers should outperform

The advent of cheaper and more novel financial products in the last decade has placed downward fee pressure on fund managers and focused attention on the merits of active versus passive fund management.

As an active manager at Wilson Asset Management my position is clear, but in finance, scepticism is healthy and robust debate is good for both investors and the industry. Investors should be clear about the benefits and faults of both management styles.

To me the biggest issue is that passive managers fail to provide a reasonable answer to the obvious question: with many good active managers in the Australian market, why should investors settle for benchmark returns? These active managers consistently beat the benchmark, after fees, over the longer term. Despite this fact, much of the criticism of active managers is centred on their level of management and performance fees or the cost of an active versus a passive managed portfolio, where the fees are significantly less.

Trends in the evolving market

Downward pressure on management fees during the past 10 years has been inescapable – most managers charged fees of around 1-2% in Australia whereas at one extreme, some overseas hedge funds charged as much 5%. This has fallen to an average of around 1% in Australia for plain vanilla long only equity funds. There is a growing trend towards no management fees, with performance fees only, where a fund manager backs their ability to beat the market providing a significant incentive system for investors.

However, we believe that in assessing the merits of an active manager it is important to look over the long term to see how they perform in all market cycles.

The latest Morningstar Australian Institutional Sector Survey 2015 found the average active large cap manager in Australia beat the market by 1.4% per annum over the past 10 years, whereas the average active small cap manager outperformed by 7.3% per annum over the same period. There is obviously a stronger argument for small cap management, where managers generally focus on undervalued growth companies where the overall market is far more inefficient.

Not all managers beat the market and thus investors should look for those that consistently outperform and ‘stick out’ in such surveys. It’s important for fund managers to have as flexible a mandate as possible and thus be as active as possible. Beware the index huggers who charge active fees.

Key drivers of outperformance

While performance fees are somewhat taboo for many investors, they play a key role in driving the right behaviour. Many active fund managers work incredibly long hours to stay ahead of the game due to performance incentives. This chase for alpha and constant attention on the market translates to benefits such as meeting with investee company management and participating in capital raisings.

Many of our active peers regularly meet with management to stay closely attuned to what the companies are doing and what management is thinking. It is no exaggeration that most active small cap managers spend the majority of their week meeting with company executives. Unsurprisingly, this research drives a lot of alpha and represents a serious value-add for investors who don’t have the time or access to do it themselves.

Institutional investors benefit from immediate access to trading opportunities, which can include initial public offerings, placements, block trades, rights issues, corporate transactions and arbitrage opportunities. These trades present active managers with the ability to access value quickly and regularly. As retail investors are (unfairly) excluded from directly participating in many of these deals, they can take part indirectly through active managers.

On an after-tax basis, an active manager can offer better results depending on the structure of the investment vehicle. We are advocates of the listed investment company (LIC) structure, which can pay investors fully franked dividends derived from its investee companies and additional franking credits from any tax paid from its own company profit. This means that over time, as a LIC investor, your after-tax return can be enhanced by the use of franking credits, depending on where those shares are held and your applicable tax rate.

Avoiding bad investments

Active managers earn their keep in volatile markets, especially in downturns, where the flexibility to reallocate assets and preserve capital is of a higher importance. In contrast, passive funds are forced to ride the storm and absorb the market’s losses. Similarly, active managers with a flexible mandate are able to avoid unattractive sectors and companies.

In Australia attempts to diversify by ‘buying the market’ through a passive index fund can backfire given the overrepresentation of particular sectors. Most investors would know enough from anecdotal evidence alone that resources have been a bad bet over the past few years. Worse still is an index’s exposure to banks, which make up 30% of the All Ordinaries Index. The recent large-scale sell off in the major banks following negative industry news single-handedly drove the index down.

Final words

Investors without the time or access required to successfully manage a portfolio are well placed outsourcing the task to a good fund manager with a consistent track record. An active manager will work hard to find good investments, avoid bad companies and sectors, and manage risk. The better ones will outperform the index return, which is all an investor will achieve with a passive manager. Both will charge for the pleasure, however we believe good active managers offer greater value than passive managers.


Chris Stott is Chief Investment Officer at Wilson Asset Management.

Chris Eastaway
May 28, 2015

Hi Chris,
Let me first say that I agree that in all things finance, ‘scepticism is healthy and robust debate is good for both investors and the industry’. And that ‘investors should be clear about the benefits and faults of both management styles’. But then I’m going to embrace my scepticism and point out a fault with the way active managers present their results (generally)!

I was under the impression that the ONLY metric that matters when managing other people’s money is how much you give them back! And, as a result, the performance of the manager should be measured not by how well the manager’s chosen investments perform in a vacuum, but by changes in the wealth of the investor, which only exists in an after cost/fees reality. Which is why, as you point out, much of the criticism of active managers is centered on their level of management and performance fees. Sorry. But fees matter.

In fact fees matter a lot. And active managers know it, which is why, even in your reference, the Morningstar Australian Institutional Sector Survey 2015 shows results “gross of on-going management fees and expenses”. If you live in the world of the investor, the average active large cap manager in Australia hasn’t in fact beaten the market by 1.4% pa over the past 10 years once fees are included. If an ASX traded ETF was used for the index holding is a comparative underperformance of about -.25%(ish). Which makes sense, since these funds are part of the market, and therefore part of the average when expressed through very long timeframes.

Over very long periods of time the results to the investor – not the manager – are almost certain to worsen as liquidity tolls such as portfolio turnover costs, management and performance fees compound against them. Survivorship bias is also worth a mention at this point because it inflates the results of the “average fund”. There is also the issue of finding those managers who can, and do, outperform the benchmark.

In the end, the beneficiary needs to be the investors, not the managers, for active management to stack up. So, does it? The answer might surprise me in any ‘chosen’ timeframe, but over 20, 30, 40 or 50 years I doubt it. The index can’t be better than average. But that’s not interesting. What is, is that over 50 years the market “average” is more than likely “better than the average return”. And that’s the kick.

Ron M
May 22, 2015

I must say the latest Cufflinks is a very good read, great reading trail regarding passive and active investing. I was also very interested in your article on Kerr Neilson's private meeting for the clients of a major adviser group, I found it very interesting and something I related to well.


Leave a Comment:



The numbers tell the story for index investing

To your taste: hot cross buns and hot, cross funds

Six investment lessons from 15 years of data


Most viewed in recent weeks

10 little-known pension traps prove the value of advice

Most people entering retirement do not see a financial adviser, mainly due to cost. It's a major problem because there are small mistakes a retiree can make which are expensive and avoidable if a few tips were known.

Check eligibility for the Commonwealth Seniors Health Card

Eligibility for the Commonwealth Seniors Health Card has no asset test and a relatively high income test. It's worth checking eligibility and the benefits of qualifying to save on the cost of medications.

Hamish Douglass on why the movie hasn’t ended yet

The focus is on Magellan for its investment performance and departure of the CEO, but Douglass says the pandemic, inflation, rising rates and Middle East tensions have not played out. Vindication is always long term.

Start the year right with the 2022 Retiree Checklist

This is our annual checklist of what retirees need to be aware of in 2022. It is a long list of 25 items and not everything will apply to your situation. Run your eye over the benefits and entitlements.

At 98-years-old, Charlie Munger still delivers the one-liners

The Warren Buffett/Charlie Munger partnership is the stuff of legends, but even Charlie admits it is coming to an end ("I'm nearly dead"). He is one of the few people in investing prepared to say what he thinks.

Should I pay off the mortgage or top up my superannuation?

Depending on personal circumstances, it may be time to rethink the bias to paying down housing debt over wealth accumulation in super. Do the sums and ask these four questions to plan for your future.

Latest Updates

Investment strategies

Three ways index investing masks extra risk

There are thousands of different indexes, and they are not all diversified and broadly-based. Watch for concentration risk in sectors and companies, and know the underlying assets in case liquidity is needed.

Investment strategies

Will 2022 be the year for quality companies?

It is easy to feel like an investing genius over the last 10 years, with most asset classes making wonderful gains. But if there's a setback, companies like Reece, ARB, Cochlear, REA Group and CSL will recover best.


2022 outlook: buy a raincoat but don't put it on yet

In the 11th year of a bull market, near the end of the cycle, some type of correction is likely. Underneath is solid, healthy and underpinned by strong earnings growth, but there's less room for mistakes.


Time to give up on gold?

In 2021, the gold price failed to sustain its strong rise since 2018, although it recovered after early losses. But where does gold sit in a world of inflation, rising rates and a competitor like Bitcoin?

Investment strategies

Global leaders reveal surprises of 2021, challenges for 2022

In a sentence or two, global experts across many fields are asked to summarise the biggest surprise of 2021, and enduring challenges into 2022. It's a short and sweet view of the changes we are all facing.


2021 was a standout year for stockmarket listings

In 2021, sharemarket gains supported record levels of capital raisings and IPOs in Australia. The range of deals listed here shows the maturity of the local market in providing equity capital.


Let 'er rip: how high can debt-to-GDP ratios soar?

Governments and investors have been complacent about the build up of debt, but at some level, a ceiling exists. Are we near yet? Trouble is brewing, especially in the eurozone and emerging countries.



© 2022 Morningstar, Inc. All rights reserved.

The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.