The amount of index-tracking funds that are sitting in the upper quartiles of their peer groups has fallen from the high levels witnessed in 2018, research by Trustnet has found. 
While passive funds tend to underperform their benchmarks due to the effects of their (admittedly small) costs, there are times when they beat active strategies – sometimes by a significant margin.
Last year was an example of this, as two-thirds of index trackers in the Investment Association universe were in either the first or second quartile of their respective sector.
As the table below shows, many sectors had a large share of their passive members in the second quartile, but some – such as IA Global Emerging Markets, IA Japan and IA Sterling Corporate Bond – had plenty of trackers in the top quartile.
Source: FE Analytics, data to 18 Nov 2019
Simon Evan-Cook, senior multi-asset fund manager at Premier Miton Investors, thinks part of the reason for this outperformance of passives is the strong returns made by large-cap growth stocks in 2018.
“There are very few active strategies that are prepared to go heavily overweight large-cap growth stocks, which made it hard for them to beat the market last year,” he said. “The managers that I track have typically always struggled when the market has been led by large-cap growth and that was happening in 2018.
“This was also a time when small- and mid-caps were struggling a little and no-one cared about valuations. Also, the fact that everyone was buying passives meant that more money was going into those big part of the index, which makes them more expensive and less attractive to active managers – so you get a bit of a self-fulfilling prophecy.
“These are not good conditions for active managers.”
That said, there are some years when index trackers fall towards the bottom of their peer groups. A good example of this was 2017, when only 5 per cent of passives were in the top quartile and 24 per cent sat in the second.
The year-to-date has seen some moderation in the number of passives making total returns high enough to put them in the top two quartiles. Our data shows that 12 per cent are in the first quartile and 31 per cent are in the second – totalling 43 per cent, against last year’s 66 per cent.
Indeed, as the table below shows, there appears to be have been a shift from passive funds out of the second quartile and into the third this year.
Source: FE Analytics, data to 18 Nov 2019
“In 2019, some of those big growth stories have started to wobble a bit, particularly in the US, and this has caused index-tracking strategies to lose some of that powerful momentum that they had behind them last year,” Evan-Cook added.
There are some exceptions, of course.
All of the index trackers in the IA Technology & Telecommunications sector are in the top two quartiles for 2019 so far and one of them – L&G Global Technology Index Trust – is its best performer this year with a 36.66 per cent total return. Last year, two-thirds of the sector’s trackers were in the bottom quartile.
There’s also been a big improvement for passives in the IA Global Bonds peer group. Last year, just 4.3 per cent of its passives were in the first quartile, with another 8.5 per cent in the second; these have jumped to 31.3 per cent and 25 per cent respectively in 2019.
Likewise, IA North America now has one-quarter of its trackers in the top quartile – up from only 3 per cent last year. Some of the best passive returns have come from Royal London US Tracker (up 25.41 per cent) and HSBC American Index (25.35 per cent) this year.
Share of index trackers in each quartile between 2015 and 2019 YTD
Source: FE Analytics, data to 18 Nov 2019
But the sectors where passives have witnessed the biggest fall down the rankings compared with 2018 include IA Sterling Corporate Bond. Here, every tracker was in the top two quartiles last year but in 2019 none are in the top-quartile and only one-quarter remain in the second.
In IA Japan, 90 per cent of trackers are currently in the third quartile and the remaining 10 per cent have made bottom-quartile total returns. In 2018, all its passives were in the upper two segments.
There’s a similar picture in IA Global Emerging Markets, where every passive fund was in the first or second quartile in 2018. This year, all its index trackers have generated third-quartile returns.
And in the IA UK All Companies peer group – which is the largest in the Investment Association universe – 89.7 per cent of trackers in the bottom two quartiles for 2019-to-date (compared with just 18.6 per cent last year).
The remaining 10.3 per cent are in the first quartile but these do not track the mainstream FTSE All Share or FTSE 100 indices. They include the likes of L&G Ethical Trust, L&G UK Mid Cap Index, HSBC FTSE 250 Index and iShares Mid Cap UK Equity Index (UK).