Are active funds better in bear markets?
- Robin Powell
- Apr 14
- 3 min read
It is often claimed that active funds offer greater protection in falling markets. Unlike index funds, active managers can hold cash or shift into bonds to avoid losses.
But the evidence suggests otherwise. According to TIM EDWARDS from S&P Dow Jones Indices, most active funds fail to beat the market in bear phases just as they do in bull runs.
If you are worried about downside risk, there may be better, cheaper solutions than relying on active management.
1. Active funds still underperform in downturns
The historical record shows active funds typically lag behind in both rising and falling markets. Though they have the flexibility to reduce risk, most managers do not time those decisions well enough to gain a consistent advantage.
2. Downside protection is not guaranteed
If you want steadier returns, you do not need an active fund to achieve them. Portfolio construction using index funds can often manage risk more reliably than relying on managers who must predict downturns in advance.
3. Outperformance in bear markets is mostly luck
Some active funds do outperform in bear markets, but the numbers suggest this is largely due to chance. On average, these funds are more volatile and often take on higher risk in search of growth, which adds to their instability.
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TRANSCRIPT
Robin Powell: It’s well known that active fund managers struggle to compete with low-cost index funds in bull markets.
But it’s often suggested that, because they have the freedom to hold cash and bonds as well as equities, they do fare better in bear markets.
So is it true?
TE: So the evidence is unequivocal. The historical record of active funds in bull markets and bear markets is not really distinguished. In strong bull markets, active managers underperform most of the time in most equity markets in the world, and bear markets.
Most active funds underperformed most of the time in most equity markets across the world. However, the one qualifier will say so that is the distinction between the potential for outperformance and the reality of outperformance.
It is true, and it remains true, that there is the potential to do better by going into cash. The question is whether or not historically active managers managed to do that.
A common misconception is that, to minimise the impact of stock market falls, it pays to be in an active fund.
RP: This so-called “downside protection” is largely a myth.
TE: If you are an investor who wishes to have participation or a degree of exposure to the equity market, but you are worried about downside risk and you do want to have more, smoother returns over time. I'll just make the observation.
You don't necessarily need an active manager to do that. There are things that an advisor can do through portfolio construction, or even index funds that will achieve those goals for you, and often in a more reliable way, as an active manager actually has to have some degree of timing.
They need to know when the market's going to go down in advance, and evidence tells us that's really, really hard to do.
RP: Simply by the law of averages, there will be active funds that DO outperform in a bear market.
But typically, the number that do so is consistent with random chance.
TE: We did a study, a couple of years ago looking at exactly this point, the volatility of active funds and how it compared to benchmarks. The results of that are as follows. First of all, on average, active funds tend to be a bit more risky than the benchmarks they're benchmarked against. Part of that could be two to concentration.
And part of that maybe just because they're looking for more growth, and looking to beat the benchmark. So the record is a bit more volatile. And when you analyse the returns it looks like a lot of that volatility is coming from higher growth. More risky stocks.
RP: To summarise, your chances of picking a fund, in advance, that will outperform in a bear market are slim.
If you’re worried about the prospect of falling markets, there are cheaper and more effective ways to manage your risk.
