Discretionary strategies no longer justify their presence in institutional portfolios
Morningstar’s latest US Active/Passive Barometer delivers a clear verdict. Active funds are not underperforming temporarily. They are failing persistently.
Between July 2024 and June 2025, only 33% of active strategies both survived and outperformed their passive peers. That figure stood at 47% the year prior. The study covered 9,204 mutual funds and ETFs managing USD 24 trillion in assets. This is not a sample. It is a representation of the market itself.
Across every major asset class and category, success rates declined. US large-cap managers recorded a 32% success rate. Mid-cap came in at 28%. Small-cap reached 30%. In the global equity space, large blend funds delivered a 22% success rate. Diversified emerging markets achieved 35%. The only segment where active equity managers materially outperformed was foreign small- and mid-cap blend, which recorded a one-year success rate of 65.5%. This was the exception. The rest of the data formed a singular pattern of erosion.
Fixed income strategies did not fare better. Intermediate core bond funds dropped from a 62% success rate in the previous period to 51.7%. Corporate bond managers posted a 3.9% success rate over one year. Morningstar’s data confirms what long-term allocators already suspect: discretionary management is delivering neither resilience nor return.
Over a 10-year horizon, the evidence is more severe. Just 21% of active funds both outperformed and survived. In US large blend, that figure was 5.8%. In large growth, 2.8%. Large value was higher at 16.3% but still structurally weak. Survivorship bias distorts these numbers upward. When adjusted for funds that were liquidated, merged, or closed, the true investor experience is worse.
Cost remains the most reliable forward indicator of performance. Among the cheapest quintile of active funds, 27% outperformed over ten years. In the highest-cost quintile, only 15% did. In US large blend, the cheapest funds achieved a 15.4% success rate. The most expensive achieved 3.9%. In large growth, 7.0% of cheap funds outperformed, versus just 1.2% of high-cost ones. Fee compression is not a strategy. It is a threshold condition for survival.
Beyond absolute performance, the shape of distribution matters. Among surviving active funds, the dispersion of excess returns in large-cap categories was negatively skewed. This means the penalty for selecting an underperforming manager exceeds the reward for selecting a successful one. In statistical terms, the asymmetry compounds capital risk over time.
Asset-weighted returns illustrate the point. Over ten years, passive large growth outperformed active by 2.3% per year. Large blend outperformed by 1.4%, and large value by 0.1%. Equal-weighted averages point to the same conclusion: active strategies, on average, extract more value than they deliver, and most of that extraction is structural. These are not anomalies. They are repeatable failures.
Morningstar found that the modal active large blend fund underperformed by 2.5% to 4.0% annually. The right-hand tail of outperformance was thin. The left-hand tail was wide and deep. These are not outliers. They are features of the system. As a result, the act of selecting a manager is now statistically closer to incurring tracking error than generating alpha.
Active management still shows strength in a narrow set of market segments. Foreign small- and mid-cap blend funds continue to benefit from inefficiencies in cross-border trading, index construction gaps, and lower liquidity. Some intermediate bond strategies maintain enough complexity to support active allocation. Real estate and high-yield funds also displayed long-term relative strength, although often within shrinking universes. These categories deserve tactical consideration. But they do not justify strategic commitment.
The broader implication is clear. Portfolio drag is now a structural feature of discretionary allocations, not an intermittent cost. The Total Portfolio Approach reframes the allocator’s task from selecting out-performers to engineering systems. Capital must be deployed where it contributes to portfolio-level efficiency, not where it conforms to product architecture or legacy benchmarks.
From this perspective, active selection is not just underperforming. It is misaligned with fiduciary purpose. The cost is no longer hypothetical. It is evident in long-term dispersion, governance complexity, and capital misallocation. The allocator who persists with manager selection as a primary function is absorbing uncompensated risk and diluting outcome accountability.
What replaces it is not a binary choice between passive and active. It is structural design. Repeatable performance comes not from choosing better funds, but from building systems that function independently of individual fund behaviour. These systems embed macroeconomic convictions, enforce risk-budget boundaries, and maintain coherence across exposures. They do not rely on forecasting. They rely on constraint, control, and consistency.
This approach does not exclude active ideas. It repositions them within a rules-based framework where their marginal contribution is measurable, bounded, and interchangeable. This restores capital discipline and portfolio precision. It avoids the behavioural cost of discretionary reallocation and the structural inefficiency of style-box investing.
Institutions that adopt this model are not giving up control. They are reclaiming it. CIOs and portfolio managers need not outsource decisions to managers. They need to reassert authority through architecture. The Total Portfolio Approach is not a framework for product selection. It is a structure for outcome alignment.
Morningstar’s barometer is not just a scorecard. It is an indictment of an allocation model that has failed to evolve. The persistent underperformance of active funds is not a problem that can be solved by more research or deeper due diligence. It is a format mismatch. The fund wrapper, designed for scalability and distribution, is now incompatible with long-term institutional capital objectives.
What remains is structure. Everything else is variance without value.
Originally posted in Substack
About the Author
Terrence Walsh leads global institutional sales at Invess.ai. The firm collaborates with CIOs and portfolio managers to replace discretionary selection with systematic, architecture-led design. Its solutions integrate macro conviction, asset allocation, and model-driven exposures to deliver capital-efficient, risk-aligned outcomes across long-term mandates.
Disclaimer
This article is for informational purposes only and does not constitute investment advice. The views expressed are those of the author and may not reflect the official position of Invess.ai. Past performance is not a reliable indicator of future results.