Time to declare “game over” for active fund management?

Is it time to declare “game over” in the contest between active and passive fund management?

Funds are pouring into Vanguard Group’s passively-managed index funds, with total assets at the firm nearing $3 trillion. No less a stock picking legend than Warren Buffett is endorsing passive – he has advised his own trustees to put 90 percent of his estate “in a very low-cost S&P 500 index fund (I suggest Vanguard’s).”

The trend isn’t limited to Vanguard, of course. Morningstar reports that 68 percent of net fund sales over the past year have gone to passive funds, and they are very dominant in U.S. stock and taxable bond funds. Asset flows to international equities are still dominated by active funds, and alternatives remain a completely active category, albeit a much smaller niche.

Performance explains the trends. A recent analysis of active funds by S&P Dow Jones Indices found that even among top active funds, very few are able to maintain strong performance over time. Among 687 funds that were in the top quartile of funds in March 2012, only 3.78 percent were still there two years later. Just 2 percent of the large-cap funds, 3 percent of mid-cap funds and 4 percent of small-cap funds remained in the top quartile.

“If anyone can beat the indices over a 20-year period with active funds, let me see it,” says Mitch Tuchman, managing director of Rebalance IRA, a company he started in 2013 to help average investors manage portfolios exclusively using low-cost index funds.

So, game over? Not quite, says John Rekenthaler, vice president of research at Morningstar, who wrote about the trend in a recent column. “There is still room for some of the active funds,” he says. “I’m not saying active is doomed to fail, but from a business perspective they appear to be losing the battle—and I don’t see that changing.”

Learn more in my column this month at WealthManagement.com.