Active vs. passive: did funds meet the mark in 2023? | U.S. equity market commentary 4Q23
Oakmark is the mutual fund family launched in 1991 by Harris Associates, the Chicago deep-value firm founded in 1976 (about $105bn AUM). Bill Nygren runs the flagship Oakmark Fund and David Herro the Oakmark International Fund, buying businesses at large discounts to intrinsic value and holding them like owners — publishing quarterly fund commentaries, market commentaries and insight articles.
In plain words
This report argues that active mutual funds (funds where managers pick stocks, not just track an index) aren't dead—they've just failed to deliver what investors need. Many funds are actually closet index funds, with tiny differences from the benchmark, yet charge high fees. The real cost of their active bets is far higher than it looks. Funds like Oakmark, with high 'active share' (how different their holdings are from the index), give you more genuine active management for a lower effective fee. So don't be fooled by low headline fees; check how much a fund truly deviates from the index.
Oakmark's Q4 2023 report notes that while active management funds have been declared "dead" by the market, this claim is exaggerated. In 2022, mutual funds saw net outflows of $960 billion, and as of November 2023, an additional $430 billion had flowed out, making it the second-worst year for the in
Theme and Background
This chapter discusses the market challenges and industry skepticism faced by actively managed mutual funds in 2023. Despite the strong performance of U.S. stocks in 2023, actively managed funds still experienced massive capital outflows, leading to a widespread belief that active management is "dead." The report's author counters this view, arguing that the problem lies in funds failing to meet shareholder needs, rather than a structural flaw in the active management model itself.
Core Argument
The author's central judgment is: Actively managed funds are not dead; their struggles stem from industry-specific issues, not a structural failure. This view stands in stark contrast to the market consensus (that active management is being phased out by the indexing trend). Oakmark believes that differentiated strategies—such as a greater focus on shareholder interests, long-term investing, and concentrated holdings—can avoid the industry's common pitfalls.
Key Arguments and Data
- 2022: Mutual funds saw net outflows of $960 billion, the worst year in industry history.
- 2023 (through November): Net outflows totaled $430 billion, making it the second-worst year for the industry.
- Despite market gains, capital outflows did not reverse but instead persisted, indicating that the issue lies not with the market environment but with the fund products themselves.
- The author quotes Mark Twain ("The reports of my death are greatly exaggerated") to draw an analogy with the current state of actively managed funds, emphasizing that market sentiment is overly pessimistic.
| Year | Mutual Fund Net Outflows (Billions USD) | Industry Ranking |
|---|---|---|
| 2022 | 9600 | Worst Year |
| 2023 (through November) | 4300 | Second-Worst Year |
Companies/Assets Involved
U.S. large-cap stock funds hold an average of 256 stocks, with an active share of 60% and a stated expense ratio of 1.10%. However, after adjusting for active share, the actual active expense ratio rises to 1.79%, with value funds at 1.49% lower than growth funds at 1.81%
- Oakmark: Used as a case study, emphasizing that its differentiated strategy (long-term investing, concentrated holdings, focus on shareholder interests) is key to avoiding industry problems. The report does not mention specific holdings or long/short positions.
- Actively Managed Mutual Fund Industry: Generally viewed bearishly by the market, but the author believes the issue is that the industry has failed to meet shareholder needs, not that the model is ineffective.
Investment Implications
- Do not be swayed by market sentiment: Massive capital outflows and media pessimism do not equate to the failure of active management. Investors should focus on a fund's actual investment strategy and alignment with shareholder interests.
- Choose differentiated funds: Prioritize actively managed funds with concentrated holdings, a focus on long-term value, and alignment of fund managers' personal interests with those of investors, rather than average industry products that follow the crowd.
- Beware of industry common pitfalls: Avoid funds that deviate from shareholder interests due to asset bloat, style drift, or short-term performance pressure.
Theme and Background
This chapter discusses how actively managed funds can prove their value through differentiated strategies, in response to market claims of their "death." The author points out that many active funds are essentially "index funds" that fail to deliver genuine active management value, while Oakmark distinguishes itself through a clear strategy.
Core Argument
The author's central thesis is that the problem with actively managed funds is not a structural flaw, but rather that many funds are not "active" enough. Investors should focus on a fund's "Active Share"—the degree to which its portfolio differs from the benchmark index—and assess whether fees are reasonable based on this metric. Counterintuitive insight: Low-fee funds (e.g., 0.23%) may have extremely high "active fees" (2.43%) due to very low Active Share (<20%), far exceeding funds with higher fees but high Active Share.
Key Arguments and Data
- Relationship Between Active Share and Fees: The author uses a simplified example to illustrate that if a fund has an Active Share of only 10% and a fee of 0.25%, the actual active fee is as high as 2.50%. The average large-cap fund has an Active Share of 60% and a fee of 1.10%, resulting in an active fee of 1.79%.
- Oakmark Comparison: The Oakmark Fund has an Active Share of 84%, a fee of 0.89%, and an active fee of only 1.05%; the Oakmark Select Fund has an Active Share of 93%, a fee of 0.98%, and an active fee of 1.06%. Both have active fees lower than the 60% average for large-cap funds.
- Category Differences: Large-cap value funds have an Active Share of 77% and an active fee of 1.49%; large-cap growth funds have an Active Share of 64% and an active fee of 1.81%. Growth funds, due to their overlap with mega-cap growth stocks in the S&P 500, have higher effective fees.
- Data Table:
Funds with Active Share below 20% have a nominal expense ratio of only 0.23%, but an active fee ratio as high as 2.43%; in contrast, the Oakmark Fund has an Active Share of 84% and an active fee ratio of only 1.05%, while the Oakmark Select Fund has an Active Share of 93% and an active fee ratio of 1.06%
| Category | Average Number of Holdings | Average Active Share | Average Expense Ratio | Average Active Fee |
|---|---|---|---|---|
| All U.S. Large-Cap Funds | 256 | 60% | 1.10% | 1.79% |
| Large-Cap Value Funds | 148 | 77% | 1.17% | 1.49% |
| Large-Cap Blend Funds | 462 | 53% | 0.98% | 2.03% |
| Large-Cap Growth Funds | 135 | 64% | 1.17% | 1.81% |
| Active Share <20% | 1489 | 12% | 0.23% | 2.43% |
| Active Share 20-50% | 637 | 40% | 0.68% | 1.83% |
| Active Share 50-80% | 137 | 65% | 1.18% | 1.83% |
| Active Share >80% | 62 | 87% | 1.33% | 1.52% |
| Oakmark Fund | 61 | 84% | 0.89% | 1.05% |
| Oakmark Select Fund | 21 | 93% | 0.98% | 1.06% |
Companies/Assets Involved
- Oakmark Fund: Active Share of 84%, 61 holdings, expense ratio of 0.89%, active fee of 1.05%. The author is bullish, viewing it as genuinely active with reasonable fees.
- Oakmark Select Fund: Active Share of 93%, 21 holdings, expense ratio of 0.98%, active fee of 1.06%. Also bullish.
- Large-Cap Growth Funds: Average Active Share of 64%, expense ratio of 1.17%, active fee of 1.81%. The author is bearish, considering them "index funds" with high fees but low active value.
Investment Implications
- Investors should evaluate a fund's Active Share: Funds with low fees but low Active Share (e.g., Active Share <20%) have extremely high effective fees and should be avoided. Funds with high Active Share (>80%), even with higher nominal fees, may have lower actual active fees.
- Prioritize funds with high Active Share: For example, the Oakmark Fund and Oakmark Select Fund have active fees (approximately 1.05%) far below the large-cap fund average (1.79%).
- Be wary of growth funds: Due to significant overlap with indices, growth funds have low Active Share and higher effective fees, meaning investors may be paying high costs for what are essentially "index funds."