Any assessment of the value of active management starts with a measurement of its success in generating returns for investors.

However, some well-known measures used to assess active managers’ performance present an overly negative assessment of active managers’ skill, explains Rethinking Survivorship Bias in Active/Passive Comparisons, a research brief from the Active Managers Council (2020). The brief takes a close look at the methodology of Morningstar’s Active/Passive Barometer.

Published semiannually, Morningstar’s Barometer plays a critical role in determining public perception of active management because of its extensive media coverage. The Barometer has become popular because it provides an easy-to-understand “success rate” for actively managed funds.  The “success rate” is  the percentage of active funds that outperform passive competitors over a given period.

Like many analyses of fund performance, the Barometer makes an adjustment for survivorship bias. These adjustments, which have been standard practice in academic research for the past 30 years, aim to reduce the risk that average performance of active mutual funds is overstated because the returns of now defunct – but likely underperforming – funds have been excluded from the calculation.

A central insight of the Council’s research brief is that the survivorship of passive funds is not significantly different from the survivorship of active funds. Adjusting active funds’ success rate by a factor derived from passive funds’ attrition results in a significantly more  positive assessment of active managers’ performance.

The paper also notes that index funds are not subject to the same survivorship bias adjustments. In the appendix, the paper estimates a success rate for passive funds, which when compared to the success rate for active funds, again leads to a more positive evaluation of active management.

While the paper focuses on the Morningstar Barometer, the research brief’s arguments also apply to the SPIVA^®scorecard published by S&P Dow Jones Indices, which has a similar purpose and approach.

More broadly, it suggests that all studies of actively-managed funds that incorporate survivorship bias adjustments may need to reconsider their methodologies if they are to make an accurate assessment of manager skill.

To review the paper, Rethinking Survivorship Bias in Active/Passive Comparisons, or learn more about active management, please visit www.activemanagers.com.