A resurgence in active management prosperity: The return of market breadth

Following a period of very narrow market breadth and relatively low volatility, we find investors are reassessing their portfolio exposures and active risk (the degree to which investment strategies differ from an index). Many global equity strategies with high active share have struggled to outperform over the past few years, and many investors have begun to reduce their active risk or are considering doing so. However, we are starting to see market drivers broadening out. That suggests we may be on the cusp of a resurgence in active management and a more prosperous period for active risk takers.

Global equities are an asset class where active managers have historically added value (on average) by taking on more active risk. When we look at the trailing 10-, 15- and 20-year periods ending March 31, 2025, the median global equity large cap manager has generally added between 0.5%-1% of excess return. The top-quartile managers were generally adding approximately 1.5%-2%, and the top 5^th percentile achieved 3%-4% of excess return, on average, over the same periods. The data suggests that the best managers were able to deliver 2%-4% in annualized excess returns over the long term. Those results beg the question: what is the right level of active risk to sustainably achieve those results?

Figure 1: Are global equity investors being compensated for their active risk?

Source: eVestment, as of March 31, 2025, based on eVestment Global Large Cap Equity universe versus the MSCI All Country World Index (net return). Returns are shown gross of fees in USD. Past performance is not a guide to future results and may not be repeated.

The data over the trailing 10-year period suggests that strategies running tracking errors above 6% have, on average, not compensated investors for the risk. Not only has the average annualized excess return been lower, but the success rate, in terms of beating the benchmark, has also been below 50%, with less than half of those managers registering positive excess returns over the 10-year annualized period. There were certainly some that were quite successful, generating excess returns of 10% or more over the period, but the dispersion was also the highest, and, on average, most failed to deliver. Interestingly, although the sample size is smaller, those managers with lower tracking error and tighter risk controls delivered the best risk-adjusted returns, on average, during the period. Most rational investors generally would not allocate capital when their win ratios are less than 50%. But investors should also be careful about extrapolating too many conclusions from this most recent 10-year period.

The odds have invariably moved against active managers in global equities over the past five years. During that period, excess returns achieved have slipped below their longer-term averages, and the most recent period actually marks the first time in the 20-year history of the global large-cap equity managers peer group that we have seen the median manager fail to generate positive excess returns (gross of fees) over the rolling five-year period.

Figure 2: Global Large Cap Equities managers have increasingly struggled to outperform in recent years…

Source: eVestment, as of March 31, 2025, based on eVestment Global Large Cap Equity universe versus the MSCI All Country World Index (net return). Returns are shown gross of fees in USD over rolling 5-year periods with 1-year intervals. Long-term average is calculated for the 20-year period. Past performance is not a guide to future results and may not be repeated.

While the temptation would be to assume that markets are increasingly efficient and active management broadly remains in decline, the same data for the “international equities” peer group suggests that this inflection is more likely a function of the extremely narrow breadth of the US market in recent years. In fact, the excess return achieved by the median non-US Large Cap manager in recent years has been well above its 20-year average and has not been negative since the period around the Global Financial Crisis of 2008-2009. This is reflective of the greater market breadth enjoyed by active managers in those markets. Meanwhile, within US Large Cap Equities, it has long been difficult for active managers to generate excess returns, with the median active manager lagging the index by more than 1% annualized over the past decade.

Figure 3: …while Non-US Large Cap Equities managers have seen increasing outperformance

Source: eVestment, as of March 31, 2025, based on eVestment Non-US Large Cap Equity universe versus the MSCI All Country World ex USA Index (net return). Returns are shown gross of fees in USD over rolling 5-year periods with 1-year intervals. Long-term average is calculated for the 20-year period. Past performance is not a guide to future results and may not be repeated.

Figure 4: US Large Cap Equities managers, on average, have struggled to outperform over the past decade

Source: eVestment as of March 31, 2025 based on eVestment US Large Cap Equity universe versus the S&P500 Index (NR). Returns are shown gross of fees in USD over rolling 5-year periods with 1-year intervals. Long-term average is calculated for the 20-year period.

The extreme concentration of the S&P 500 Index (as seen in Figure 5 below) and very narrow market breadth driving US equity returns have proven to be quite challenging for active investors over the past few years. With a significantly smaller group of mega-cap stocks driving markets, active stockpickers on average have not been rewarded for significantly deviating from the index. This has also had a more pronounced impact on global equities, as we have seen the weight of the US market grow in the MSCI All Country World Index (ACWI) from approximately 52% to 66% over the past 10 years. The weight of the “Magnificent 7” US technology stocks in the MSCI ACWI is roughly the same as the total of the next largest eight countries’ entire weight combined. (See Figure 6 below.) That poses an increased challenge to active investors if they don’t have significant exposure to those companies. But at the same time, that increased concentration presents greater diversification risk for passive investors, particularly if we continue to see a reversal of those companies’ market leadership, as we have seen already in the early part of 2025.

Figure 5: Weight of 10 largest stocks in S&P 500 has nearly doubled from its long-term average

Source: S&P. S&P 500 Index top 10 issues annually by percent of index market value from 1980-2024. Full market values (not adjusted for float) are used for historical comparison.

Figure 6: “Magnificent 7” US companies make up the same weight in MSCI ACWI than the next eight biggest countries combined

Source: LSEG Datastream, Schroders. As of December 31, 2024

The rolling five-year excess returns for global equities managers (shown in Figure 2 earlier) have varied over time but generally have been close to +1%, which structurally favors active management. When we look at the measures of market breadth, the last five years have been particularly challenging for global equity active managers. In fact, the percentage of MSCI World Index constituents outperforming the index has been near its lowest levels in 20 years in four out of the past five calendar years (shown in Figure 7 below). The one exception was 2022, which was a year marked by significant sector, style and factor rotation as slowing economic growth, inflationary pressures and tightening monetary policy led to a market selloff in nearly every part of the market except the energy sector. In this context, it is perhaps not surprising to see that these have also been among the most challenging calendar years for active managers to deliver excess returns.

Figure 7: Global equities’ market breadth has been the lowest in 20 years in four out of the past five calendar years.

Source: MSCI, Schroders, as of December 31, 2024. Past performance is not a guide to future results and may not be repeated.

The most recent five-year period (Figure 8) highlights that managers taking on more active risk have generally seen lower success rates, and the payoff for taking that risk has also been poor. However, when we look at the prior 10-year period, we can see that not only were the success rates quite strong across the board, but the payoff for taking on increased active risk was also, on average, notably better. While market volatility was generally quite low during that period, market breadth was higher. That created a better backdrop for active stockpickers to capture opportunities to deliver excess returns.

Figures 8a and 8b: While increased active risk has largely not rewarded global equity investors over the past five years, it was notably more well rewarded in the decade prior.

Past performance is not a guide to future results and may not be repeated.

Source: eVestment, as of March 31, 2025 based on eVestment Global Large Cap Equity universe versus the MSCI All Country World Index (net return). Returns are shown gross of fees in USD.  Past performance is not a guide to future results and may not be repeated.

The Fundamental Law of Active Management, developed by Richard Grinold and Ronald Kahn in 1999, proposes that optimal active return is built on two factors: skill and breadth. This implies that a manager’s ability to generate alpha is predicated on how well they forecast and how many independent bets they make. It is important to assess the consistency of alpha generation over time through different market conditions to make a proper distinction between skill and luck. It is also important to be mindful of breadth. An index dominated by a few large stocks can make it difficult for active managers to demonstrate the value of their approach if they are not exposed to those stocks, even if their other stock picks are sound.

With relative expectations improving for non-US stocks and the growth drivers within US equities broadening out, the active opportunities for investors are seemingly expanding. Several technical indicators also suggest that the market is potentially transitioning toward a period of increased breadth, a circumstance that could pave the way for a resurgence of the benefits of active management. The data would suggest that skilled managers are more likely to be compensated for taking active risk in a period of increased breadth, and we could see an improvement in success rates across the risk spectrum. In a lower return environment, the value of alpha can also be quite substantial. While passive investing has put more pressure on active investing to demonstrate the value for cost, now may be the time for active managers to remind investors why they are worth the premium.  

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Originally Posted on June 23, 2025 – A resurgence in active management prosperity: The return of market breadth

Endnote:

1. Source: eVestment, as of March 31, 2025, gross of fees in USD. Data assesses the eVestment Global Large Cap Equity Universe against the MSCI All Country World Index (ACWI) over the various time periods. For the 10-year period, the universe included 418 products; for the 15-year period, 241 products; and for the 20-year period, 120.

Glossary:

Active risk (also known as tracking error) is a measure used in investing to show how much a fund’s returns differ from those of its benchmark index. It tells you how closely (or not) a fund follows its benchmark. Higher active risk means the fund’s performance is more different from the benchmark, and the fund manager is making more independent decisions. Lower active risk means the fund’s returns are very similar to the benchmark and the fund is not deviating from the index very much.

Active share is a measure used in investment management to quantify how much a portfolio’s holdings differs from its benchmark index. It expresses, as a percentage, the extent to which the weights of the fund’s investments deviate from those of the benchmark. A high active share (close to 100%) means the portfolio is very different from the benchmark, indicating more active management. A low active share (close to 0%) means the portfolio closely tracks the index, thereby suggesting a more passive approach.

Alpha refers to how much a portfolio’s returns differ from a benchmark’s. Positive alpha suggests outperformance; and negative alpha, underperformance.

The “Magnificent 7” stocks are a group of seven large, influential technology-focused companies in the US stock market. The seven stocks are Alphabet (Google), Amazon, Apple, Meta Platforms (Facebook), Microsoft, Nvidia and Tesla.

Tracking error is a risk measure used in investment management to quantify how closely a portfolio follows the performance of its benchmark index. More specifically, tracking error is the standard deviation of the difference in returns between a portfolio and its benchmark over a specified period. It reflects the degree of active management, with higher tracking error indicating greater deviation from the benchmark.

Volatility is a measure of how much the price of an investment goes up and down over time. Investments with high volatility can change in value quickly and by large amounts, while investments with low volatility tend to have smaller, steadier price changes. Volatility provides insight into how risky or stable an investment might be.

The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.