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Morningstar: active outperforms in Europe over long term

Europe ex-UK large cap active funds had highest success ratio over 16-year test period, according to research firm


The median performance of European active fund managers has beaten the benchmark across 12 Morningstar categories with Europe ex-UK large cap leading the way.

A Morningstar report published last month posed the question: Should you go active in European Equity? And examined the performance of active funds from 2002 to 2018 over rolling five-year periods.

The research found that on average, funds had a positive gross excess median return of 1.06% annualised against the chosen category index over the entire period.

It also suggested that by selecting an above-average fund, investors can outperform with a comfortable margin in European equities in addition to fees.

“Funds in the best quintile have beaten the category index in all 12 categories even after retail-investor fees. However, selecting a long-term outperformer is a challenging task, as the excess returns of the top performers can fluctuate heavily, and the range of outcomes within a category can be extremely wide,” the Morningstar report said.

The Europe ex-UK large cap category demonstrated the highest success ratio for investors suggesting that even if they had selected an average active fund, it should have performed better than the benchmark.

“The category has the highest success ratio coupled with a moderate dispersion of returns suggesting that investors are typically better off choosing an active fund,” the report said.

It is, however, not all good news for active managers when fees are applied. When the ‘full-freight retail investor’ fees are applied, 10 out of the 12 categories see negative excess returns against the index.

However, in five out of 12 categories, the median fund was enough to beat the institutional or clean share class.

The research also suggested that the ease of selecting a fund that outperforms depends on the category.

Dispersion fuels confidence

In categories such as Europe large cap blend equity and eurozone large cap equity, the median is fairly close to zero with funds within a tight range making it possible to forecast excess gross returns with a high degree of confidence.

This is more difficult in categories with a high dispersion of returns – in categories such as the Europe flex cap, Europe mid-cap and eurozone mid-cap and eurozone small cap.

The report groups the 12 categories into two groups – those with low to medium dispersion and those with high to medium dispersion.

It found that in the former group, in the median five-year period, funds matched or outperformed the index between 58% and 82% of the time before fees. Between 32% and 62% of funds have been able to generate a 1-percentage-point margin of outperformance, while between 19% and 45% of funds achieved a 2-percentage-point outperformance at the gross level.

Group 1

Although the second group can be selected with less confidence of outperformance, it still offered rewards.

In the typical five-year period, Group 2 funds have been able to outperform before fees 56% to 79% of the time depending on the category.

Compared with Group 1, however, a larger proportion of funds have been able to outperform the index by 1 percentage point or more (40% to 68%), and a considerable portion (28% to 55%) by 2 percentage points or more. This suggests that Group 2 has been a more lucrative area for active equity managers, at least on a gross-of-fees basis.

Group 2

However, as the report notes the category also demonstrates the challenges of selecting a fund from this second group.

“Median funds in the Europe flex-cap equity category have beaten the MSCI Europe TR Index (1.87% median excess return), before accounting for fees. But the category exhibits high internal dispersion (4.22%), so investors can have easily ended up with an underperforming fund.”

Full freight fees hinder outperformance

Overall, the percentage of funds which managed to outperform the index accounting for fees was only between 25% for Europe large cap blend equity and 56% Europe large cap ex UK.

Those beating the index by 1% ranged from 11% to 29% and by 2% ranged from 6% and 27%.

The report emphasised that is a comparison using ‘full-freight’ fees and suggests that with several European markets banning rebates, costs should reduce in future as fundholders invest through clean share classes.

The paper does make the proviso that fund mortality does weigh on certain sectors. The average survival rate was 79% but it fell as low as 61% in the Europe large cap value category.

The long run success ratio, which accounts for fees as well as fund mergers and liquidations, is more than twice as high in some categories. The median success ratio over all five-year rolling periods ranged from 19% for Europe large cap blend equity to 47% Europe ex-UK large cap equity.


Morningstar analysed patterns of Europe-equity fund performance against category benchmarks and passive options on a gross and net-of-fees basis with a data set that ran from January 2002 to end-September 2018.

The study included all open-ended funds in Morningstar’s database for 12 Europe, Africa, and Asia categories with a focus on European equities and included liquidated or merged funds that were alive for at least one five-year period within the time frame of the study.

The dataset includes 3,039 open-end funds, with 1,923 funds displaying a return for the most recent five-year period; others had been merged or liquidated before the end of September 2018.