This piece explores whether active fund managers can beat the market. Jeff Ptak of Morningstar says only about 8% succeed long-term, and key predictors are low fees, high manager ownership, and low turnover. He still recommends Sequoia Fund despite a decade-plus of underperformance, citing its discipline. Dodge & Cox and Capital Research are praised for stable teams. Ptak warns that even winning funds can trail benchmarks for 10+ years, so impatient investors should just buy index funds.
Jeff Ptak (Morningstar’s Global Head of Manager Research) discussed the current state and outlook of active management in a podcast. Drawing on Morningstar’s dual perspectives—bottom-up (deep due diligence on investment strategies and firms) and top-down (industry data trends)—he revealed the challe
Jeff Ptak (Global Head of Manager Research at Morningstar) examines the challenges and opportunities facing active management funds from both a bottom-up (deep due diligence) and top-down (industry data) perspective. Core thesis: Active management is not universally ineffective, but the probability of success is extremely low—only about 8% of funds outperform their benchmarks after accounting for investor timing behavior. Success depends on specific variables (low fees, high manager ownership, low turnover), and investors must exercise extreme patience.
Jeff Ptak argues that the underperformance of active management funds relative to passive indices in recent years is primarily driven by three cyclical factors, rather than structural failure.
Historical Context and Mechanism Breakdown:
Ptak points out that the massive shift of capital from active to passive is a long-term trend of "high-cost to low-cost," but the underperformance of active funds has specific causes:
1. Style Leadership: Large-cap growth stocks have consistently outperformed small-cap and value stocks, while large-cap growth fund managers typically have "impure" holdings (with exposure to small/mid-cap and value stocks), causing them to lag behind "purer" indices.
2. Market Trend: Active funds have a higher success rate in declining markets, but the past period has been a prolonged bull market.
3. Dispersion: The return gap between styles has narrowed, reducing the excess returns active managers can generate from style tilts.
Extrapolation and Conditions for Falsification:
Ptak believes that if the following three conditions reverse, active funds may see a cyclical recovery:
> "If those three things reverse... it could slow [the shift to passive] a bit and give active managers maybe their day in the sun again."
Jeff Ptak argues that screening active funds should prioritize four quantifiable metrics, with fees being the strongest predictor of success.
Data Chain:
Implications:
Ptak emphasizes that these metrics are "a starting point, not an endpoint." For example, low turnover alone is meaningless; it must be interpreted within the context of the strategy to understand "why no trading occurs"—which can reveal how the manager thinks about the market.
Through research, Jeff Ptak demonstrates that funds with long-term outperformance often endure underperformance periods lasting over a decade, requiring extreme patience from investors.
Historical Context and Data Chain:
Ptak analyzed "successful" funds with multi-decade track records and positive cumulative excess returns, finding that they commonly experienced underperformance periods exceeding 10 years. He cites Sequoia Fund as an example: despite struggling over the past 10–15 years, Morningstar continues to recommend it due to its discipline, research culture, and management commitment remaining intact.
> "These funds... spent many, many years looking up at their benchmarks, 10-plus-year periods. It was not uncommon for that to happen."
Implications:
Ptak notes that this fact explains the wide gap between "time-weighted returns" and "investor returns" (dollar-weighted) — investors frequently enter and exit due to an inability to tolerate prolonged underperformance, resulting in actual returns far below the fund's own performance. He warns: "For many of us, that's too much to ask for. And for those of us, we should index rather than invest in active funds."
Jeff Ptak argues that frequent trading by investors is the primary cause of the behavior gap, and excessive transparency may exacerbate this issue.
Mechanism Breakdown:
Ptak points out that Morningstar's "investor returns" data show target date funds are among the few categories with a "positive gap"—where actual investor returns exceed the fund's own returns. The reasons are:
Conversely, high-volatility equity funds (especially sector funds) lead investors to trade frequently amid fear and greed, with the behavior gap reaching 5%-7% annualized.
Deductions and Recommendations:
Ptak supports the "prudent use" of purchase/redemption fees (e.g., nominal fees charged by some Vanguard funds) to curb short-term trading. However, he warns that large front-end sales loads or punitive redemption fees can be "predatory." He advises investors to clarify before buying an active fund: "This is something we're going to own for some period of time... there's probably going to be some underperformance along the way."
Jeff Ptak is a public advocate of performance-based fees, arguing that they can improve managers' capacity management.
Mechanism Breakdown:
Ptak points out that the current "Fulcrum Fee" structure of 40 Act mutual funds has a flaw: the fixed base fee far outweighs the floating component, limiting its impact on manager behavior. However, he believes that if performance fees are properly designed, they can compel managers to manage strategy capacity more prudently — proactively closing strategies before scale expands, rather than waiting until "bloat" becomes inevitable.
> "If a performance-based fee can help managers... make them more disciplined about capacity management, that could be a big win for investors."
Extrapolation:
Ptak acknowledges that the "2/20" fee structure of hedge funds is "ridiculous," but its performance fee component is worth learning from. He predicts that active management fees will continue to decline (currently at an asset-weighted average of 61 basis points), and performance fees will become a fair way for managers to compensate for falling revenues.
| Position | Guest Stance | Key Data |
|---|---|---|
| Sequoia Fund | Bullish (still recommended, but less strongly than before) | Underperformed over the past 10-15 years, but Morningstar believes its discipline and culture remain unchanged |
| Dodge & Cox | Positive mention (example of team management) | No specific data provided |
| Capital Research (American Funds) | Positive mention (research-intensive, investor-centric) | No specific data provided |
| Prime Cap Management | Highly praised (best research experience) | Long-term incentives, manager shareholding, analyst-managed portfolios |
| DFA (Dimensional Fund Advisors) | Positive mention (culture, distribution) | Significant divergence between dollar-weighted and total returns in emerging market value fund |
| Vanguard | Positive mention (scale advantage, distribution) | Asset-weighted average expense ratio of 61 basis points |
| Franklin Resources | Neutral mention (global distribution was once a moat, now commoditized) | No specific data provided |
| Third Avenue | Negative case (failed generational transition) | Severe issues emerged after Marty Whitman's handover |
| iShares | Positive mention (successful ETF distribution) | No specific data provided |
1. Expense is the strongest predictor of active fund performance (Jeff Ptak): The probability of success for funds in the cheapest quintile is 3 times that of funds in the most expensive quintile.
2. Successful funds typically endure underperformance periods of over 10 years (Jeff Ptak): Sequoia Fund is a classic example—long-term underperformance does not necessarily mean "losing the magic"; it may simply be the price of patience.
3. Investor behavior gaps can reach 5%-7% annualized (Jeff Ptak): Target-date funds are a rare exception (positive gap), as they reduce trading impulses through controlled environments and low volatility.
4. Low turnover reveals a manager's "irrevocability" mindset (Jeff Ptak): Managers who buy with the intention of holding for 4-5 years tend to be more prudent and more focused on avoiding major mistakes.
5. Performance fees can improve capacity management (Jeff Ptak): If properly designed, performance fees can force managers to proactively close strategies before scale inflates—something the current asset-based fee structure cannot achieve.
6. Transparency is a double-edged sword (Jeff Ptak): Excessive scrutiny of holdings and short-term performance leads to overtrading, widening the behavior gap. Buffett's mindset of "the stock market is closed for five years" is worth emulating.
7. The triple headwinds against active management can cyclically reverse (Jeff Ptak): If three conditions—style leadership shifts, market corrections, and increased dispersion—are simultaneously met, active funds may experience a period of recovery.
8. Managers holding over $1 million in their own funds are a minority (Jeff Ptak): Far fewer than 50% of funds have managers meeting this disclosure threshold, which sends the strongest signal of conviction.