Why Active Funds Are Failing to Outperform Index Funds: Morningstar’s Wake-Up Call for Investors Seeking Smarter Strategies
In the ongoing battle between active and passive investing, the latest data from Morningstar delivers a clear—and somewhat sobering—message for investors: active funds continue to struggle mightily to outperform their index fund counterparts, even in volatile markets where they are supposed to shine.
The Active vs. Passive Showdown: Why Active Managers Are Losing Ground
Active funds, managed by professionals who handpick stocks, bonds, and other assets, have traditionally pitched their ability to navigate market turbulence better than passive funds, which simply track a market index. The theory: during periods of geopolitical uncertainty, tariff disputes, or economic roller coasters, skilled managers can dodge losses and seize opportunities that passive investors miss.
But the reality? According to Morningstar’s August 2025 report, only 33% of actively managed mutual funds and ETFs outperformed their average index fund peers from July 2024 through June 2025—down a sharp 14 percentage points from the previous year. This trend isn’t new or fleeting. Over the past decade, a mere 21% of active strategies managed to beat their benchmarks after fees.
Bryan Armour, Morningstar’s director of ETF and passive strategies research for North America, sums it up: “Conventional wisdom says active managers should better manage those complexities, but performance says otherwise.”
Sector-Specific Success: Where Active Managers Still Have an Edge
Not all active funds are created equal. The data reveals that active management is particularly weak in large-cap U.S. stocks. For example, only 14% of actively managed U.S. large-cap funds have beaten the S&P 500 over the past 10 years, according to SPIVA data. Moreover, when these funds do underperform, they tend to do so by a larger margin, amplifying losses for investors.
However, active management shows more promise in less efficient markets where information is scarcer and opportunities for skilled stock picking abound. These include fixed income, real estate, small-cap stocks, and emerging markets. For instance, 43% of actively managed high-yield bond funds outperformed their index benchmarks over the past decade, a far better success rate than in large-cap equities.
The Fee Factor: The Silent Profit Killer
Fees remain the silent but deadly culprit behind active funds’ underperformance. Morningstar reports that index funds carry an average asset-weighted fee of just 0.11%, while active funds charge around 0.59%. This seemingly small difference compounds dramatically over time. The SEC illustrates this with a simple example: an investor earning 4% annually on $100,000 would end up with $29,000 less over 20 years by paying a 1% fee instead of 0.25%.
This fee drag means active managers must deliver significantly higher returns just to break even with index funds—a tall order in any market environment.
What Investors and Advisors Should Do Differently Now
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Reassess Active Exposure: Given the persistent underperformance and fee drag, investors should critically evaluate the active funds in their portfolios. Are these funds in sectors where active management historically adds value, like high-yield bonds or emerging markets? Or are they large-cap equity funds where index funds dominate?
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Consider Hybrid Approaches: Advisors might explore a “core-satellite” strategy—using low-cost index funds for the core portfolio and selectively allocating to active funds in niche areas with higher active management success rates.
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Focus on Fee Transparency and Value: Investors must scrutinize fees closely and demand transparent reporting. Even small fee reductions can significantly enhance long-term returns.
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Stay Alert to Market Shifts: The geopolitical and tariff-driven volatility that active managers hoped to exploit did not translate into outperformance. Going forward, investors should be cautious about assuming active management will protect them in turbulent times.
A Unique Insight: The Impact of Market Rebounds on Active Strategies
A revealing example from 2024 highlights a critical challenge for active managers. When President Donald Trump announced reciprocal tariffs in April, many active managers reduced risk exposure. However, the market rebounded quickly, leaving those managers behind. This illustrates a key weakness: active managers often react to headline risks but may miss rapid recoveries, whereas index funds capture the full market rebound by design.
Looking Ahead: What’s Next for Active vs. Passive?
As passive investing continues to grow—Morningstar reports that passive funds now account for over 50% of U.S. equity fund assets—active managers face mounting pressure to justify their fees and strategies. The future may see more innovation in active ETFs and smart beta strategies that blend passive indexing with targeted active elements.
For investors, the takeaway is clear: passive investing remains the cornerstone for most portfolios, especially in large-cap equities. Active management should be reserved for areas where skilled managers have a demonstrated edge and where fees are reasonable.
Final Thought
The data and trends are unequivocal—active management is not the panacea for market volatility it’s often claimed to be. For investors and advisors committed to maximizing returns, embracing low-cost, broad-market index funds while strategically deploying active funds in niche sectors is the smartest path forward. Staying informed, vigilant, and fee-conscious will be the keys to navigating the evolving investment landscape in 2025 and beyond.
Sources:
- Morningstar (2025 Active vs. Passive Report)
- SPIVA U.S. Scorecard (2025)
- U.S. Securities and Exchange Commission (Investor Fee Impact Study)
Source: Active funds struggle ‘mightily’ to beat index funds: Morningstar
