For decades, the active-versus-passive investing debate has split the financial world. On one side stand advocates of low-cost index funds, armed with data showing that most active managers fail to beat the market over time. On the other are star stock-pickers and their clients,convinced that skill,insight and agility can still generate consistent outperformance.
Yet as markets grow more efficient, fees come under pressure and technology reshapes how portfolios are built, the question is becoming more pointed: is there still any real benefit to investing in active funds?
Drawing on research and expert insight from London Business School, this article examines what the evidence actually shows. It explores where – and under what conditions – active management may still add value, when investors are better served by passive strategies, and how a more nuanced view of “active versus passive” is quietly reshaping the industry.
How London Business School research challenges the case for active management
Drawing on decades of empirical data, London Business School academics have repeatedly found that most stock pickers struggle to beat the market once fees, trading costs and survivorship bias are factored in. Their research shows that what often looks like skill is frequently exposure to common risk factors – such as size, value or momentum – that could be captured more cheaply through carefully constructed index strategies. Simply put, many high-fee portfolios behave like expensive replicas of broad market indices, delivering benchmark-like returns while quietly charging investors a performance premium.
Crucially, the School’s studies also highlight how a minority of managers may display genuine skill, but this edge is fragile, hard to identify in advance and swift to disappear once capital floods in. Investors, thus, face an asymmetric bet: they pay active prices without a reliable way to secure active outperformance. Research-led implications for investors include:
- Scrutinise fees – even small percentage differences compound sharply over time.
- Demand clear evidence of repeatable skill, not just a short burst of strong returns.
- Understand factor exposures rather than paying active fees for hidden index tracking.
- Use low-cost passive funds as a benchmark for any active proposal.
| Finding | Implication for Investors |
|---|---|
| Most active funds lag net of fees | Start with passive as the default option |
| Outperformance rarely persists | Be sceptical of “star” managers |
| Returns frequently enough mirror common factors | Check what you’re really paying for |
Where active funds can still add value in a largely passive world
Despite the dominance of low-cost index trackers, there remain pockets of the market where skilled stock-pickers can still justify their fees. Less efficient segments – such as small-cap equities, emerging markets and certain areas of credit – often feature thinner analyst coverage, lower liquidity and slower details flow, creating mispricings that systematic trackers are slow to exploit. Complex or event-driven situations – distressed debt, corporate restructurings, spin-offs, IPOs and special situations – can also benefit from human judgement, deep due diligence and active engagement with company management. In these niches, active managers with a clear edge, disciplined process and tight risk controls can generate returns that materially outpace broad market beta over the long term.
- Market inefficiencies: small caps, frontier and emerging markets
- Complex assets: high-yield bonds, structured credit, alternatives
- ESG stewardship: active voting, direct company engagement
- Risk management: adaptability to raise cash or hedge in stress periods
| Segment | Passive Advantage | Active Edge |
|---|---|---|
| Large-cap developed equity | Ultra-low cost, tight tracking | Limited, mostly in risk tilts |
| Small-cap & micro-cap | Broad exposure but shallow depth | Stock selection, liquidity awareness |
| Emerging markets | Cheap access to beta | Country, currency, governance insight |
| Credit & alternatives | Fewer pure index options | Security selection, downside protection |
For investors constructing diversified portfolios, the implication is not a binary choice but a hybrid allocation that uses index funds as the core and reserves active risk budget for those specific areas where the odds of outperformance are structurally higher. The emphasis shifts from asking whether “active beats passive” in aggregate to identifying which types of active strategy,in which markets,under what constraints,can reliably earn back their costs.In a world where most capital is now passively allocated, the selective use of genuinely differentiated active funds can function less as a speculative bet and more as a targeted tool for sharpening returns, managing risk and aligning with long-term, values-driven objectives.
What investors should examine in fees performance and manager skill before backing active funds
Before committing capital, investors need to dissect the fee structure with the same forensic rigour they’d apply to a company’s balance sheet. It’s not just about headline annual management charges, but the full “all-in” cost that erodes returns over time. Key elements include:
- Ongoing charges – the recurring drag on performance, even in flat markets.
- Performance fees – how they’re calculated, the benchmark used, and whether there is a high-water mark.
- Trading costs – portfolio churn,bid-offer spreads and market impact,frequently enough hidden in the background.
- Share class differences – platform, institutional or clean share classes with materially different cost profiles.
| Metric | Low-Fee Fund | High-Fee Fund |
|---|---|---|
| Ongoing Charge | 0.45% | 1.80% |
| Turnover | 20% p.a. | 120% p.a. |
| 10-Year Excess Return | +0.6% p.a. | +0.2% p.a. |
On the other side of the ledger is manager skill,which must be demonstrated rather than promised. Investors should look beyond raw returns to evaluate:
- Consistency of alpha – outperformance across different market regimes,not just one bull phase.
- Risk-adjusted metrics – Sharpe and information ratios that reveal whether returns justified the volatility.
- Benchmark clarity – a transparent, appropriate index against which skill can be credibly measured.
- Process and philosophy – a repeatable, documented framework rather than star-manager intuition.
- Team stability – low turnover among key decision-makers and a culture of aligned incentives.
How to build a pragmatic portfolio combining passive cores with selective active satellites
One way to reconcile the evidence in favour of low-cost indexing with the allure of skilled stock-picking is to separate your investments into a stable backbone and a series of precisely targeted overlays.The backbone is a low-fee, globally diversified index fund or ETF, designed to capture broad market returns with minimal friction. Around this,investors can add smaller,higher-conviction positions in active funds where there is a plausible edge-typically in less efficient corners of the market,or where a manager’s process,incentives and track record are unusually strong.In practice, this means being explicit about which role each holding plays: is it a core risk driver or a tactical satellite?
The discipline lies in being selective and systematic. A pragmatic framework might include:
- Define the core: Use global equity and bond index funds as the default home for most of your capital.
- Cap the satellites: Limit active satellites to a modest share of the portfolio-often 10-30%-to avoid style drift.
- Target inefficiencies: Focus active exposure where markets might potentially be less efficient (small caps, emerging markets, niche credit).
- Demand clear edge: Look for transparent investment processes, sensible capacity, and fair, performance-aligned fees.
- Review ruthlessly: Set pre-defined metrics and timelines for evaluating whether each active fund is earning its keep.
| Portfolio Block | Typical Role | Indicative Share |
|---|---|---|
| Passive global core | Market return, cost control, diversification | 70-90% |
| Active equity satellites | Selective alpha in niches | 5-20% |
| Active fixed income / alternatives | Income, diversification, downside defense | 0-15% |
In Conclusion
the question is less about whether active management is “worth it” in the abstract and more about what, precisely, an investor is trying to achieve-and at what cost. The evidence suggests that consistent outperformance after fees and taxes remains rare, and that many so‑called active funds are little more than index trackers in disguise. Yet London Business School’s research also shows that, under specific conditions and with genuinely active managers, there can be pockets of possibility.
For investors, the task is twofold: to be clear‑eyed about the structural advantages of low‑cost passive strategies, and equally clear about the narrow, demanding criteria any active fund must meet to justify its place in a portfolio. That means scrutinising fees, turnover, active share and the robustness of a manager’s process rather than relying on past returns or marketing claims.
As markets evolve and new sources of data and complexity emerge, the debate over active versus passive will not disappear. But armed with the empirical insights from academic studies and the discipline to interrogate where value is really being added, investors can move beyond ideology-and treat active funds not as a default option, but as a targeted, evidence‑based choice.
