Why beating the Index in Equities is So Hard

Every few years, the same conversation pops up again.

An active manager underperforms the market. Headlines follow. Clients ask questions. Advisers find themselves explaining (again).

But zoom out for a moment, and this isn’t really about any one fund or manager.

It’s about a bigger idea.

In listed equities, beating the index is possible - but it’s structurally difficult. And the longer the timeframe, the harder it tends to get.

This discussion is specifically about listed equity markets. The trade-offs can look different in other asset classes, including fixed income, where benchmarks, liquidity, risk management and security selection can make active implementation more relevant.

If you look across equity funds, a clear pattern shows up:

• Over short periods, results are mixed - some active funds outperform, some don’t
• As the horizon expands, survivorship starts to matter. Noting that some funds captured in this category are due to renaming or takeovers
• Over longer periods, the pool of outperformers shrinks

We’re not saying active management in equities “doesn’t work”, rather, the odds of outperforming consistently after fees are tougher than they first appear.

So what’s driving that? Let’s unpack it.

To put it simply, in equities, active funds typically charge more than index-tracking alternatives. For example,

• A low-cost index fund might charge around 0.25% - 0.30% p.a.
• An active equity fund might charge 1% - 2% p.a.

If the fee gap is 0.75%, the manager needs to add at least 0.75% in extra return every year just to keep up.

For clients, this is often a part that gets overlooked.

Something that surprises a lot of investors: Most stocks don’t drive market returns. A few winners do most of the work.

In any given period:

• Many companies deliver average or below-average results
• A handful of “outliers” generate outsized returns
• Those few winners often account for a large portion of total market performance

This creates a challenge for active equity managers.

If you:

• Miss those winners
• Own too little of them
• Or sell them too early

…it becomes very hard to keep up with the index - even if most of your other decisions are reasonable.

Index funds, by design, hold the market broadly. That means they naturally capture the outsized winners as they grow in market value, helping offset the stocks that deliver average or below-average returns.

Active managers in the equity market must identify those winners in advance and hold them with conviction. That’s not easy. For example, in the below graph 75% of all stocks over this period performed worse than average.

Listed equity markets are intensely competitive. Prices reflect the views of thousands of professional investors, analysts, trading firms and algorithmic trading tools, all working with significant resources and information.

That doesn’t make outperformance impossible. But it does mean it’s harder to sustain.

It’s important to be precise here. The evidence around persistent outperformance is particularly challenging in listed equities, especially broad, developed markets. This should not be generalised to every asset class.

Not at all. But it does change how we think about it.

Instead of asking “Will this manager beat the market?”, a more useful stance is “What role does this play in the portfolio - and is it worth the cost?”

There are still valid reasons to use active management in some contexts, including:

• When the goal is risk management, not just outperforming an equity index
• When a strategy offers something meaningfully different from the benchmark
• In less efficient or more constrained parts of the market
• When there is a clear, well-understood investment approach (and realistic expectations around outcomes)

The key is being deliberate.

For many investors, a practical approach looks something like this:

A strong core of low-cost index exposure can provide:

• Broad diversification
• Market returns (by definition)
• A reliable foundation

Selective active exposure added on top:

• Where there’s a clear purpose
• With an understanding of the trade-offs (including fees and variability of returns)
• And with a long enough timeframe to assess outcomes fairly

One of the most valuable things advisers can do is set expectations early.

Here’s a simple way to frame it:

• Active equity management can outperform, but it won’t always
• Periods of underperformance are normal, even for skilled managers
• Fees and market structure make consistent outperformance in equities difficult
• A well-designed portfolio doesn’t rely on any single manager or outcome

When clients understand this upfront, they’re far more likely to stay invested - which, in the long run, matters far more than picking the “perfect” manager.