My colleague Amy Arnott recently wrote about the fallacy of the “stock-pickers” market. Time and again, active management’s proponents contend the time is ripe for portfolio managers to beat the indexes, only for results to disappoint. As Amy explains, it’s always and never a stock-picker’s market, making it wise to take these claims with a grain of salt.
Another related notion is that active stock managers excel in downturns. The argument goes something like this: Because individual active fund managers have the leeway to invest wherever they choose (within limits), and even to hold some cash in reserve, they’re better equipped to weather a bear market than an index that feels the full brunt.
I’ve looked at this before, but it’s been a while, so I ran a fresh test, compiling every active stock fund’s rolling one-, six-, 12-, and 36-month returns over the 26-year period ended Oct. 31, 2025. I compared those returns to the rolling returns of an index that matched each fund’s style at the start of each rolling period. Then I counted the number of funds with positive or negative excess returns in up (that is, index had a positive return during the rolling period) and down (index had a negative return) markets.
Here’s what I found:
Active stock funds did indeed succeed more often during down markets. For instance, they outperformed in about 51% of the rolling 36-month periods in which their benchmarks lost, compared with 38% when the index gained. The results were similar for the rolling one-, six-, and 12-month periods, too. (Note the actual success rates were lower than shown, as the above excludes the results of any fund that started but didn’t complete a rolling period.)
Success rate is one thing, but how about average margin of outperformance in these up and down periods? I looked at that too, as shown below:
The average successful active fund outperformed its index by a wider margin in down periods than up periods, no matter how long the rolling period was. For instance, the average active fund that beat its benchmark over a “down” 36-month period (that is, the index lost over the 36-month rolling period) did so by around 4% annually, or about 1 percentage point more per year than the average active fund that beat in an “up” period.
So, in summary, it appears active stock funds were likelier to beat their indexes in a down market than an up market. Moreover, when they outperformed their benchmark, the average fund did so by a wider margin in a down market than it did in an up market.
Spike the Football?
This might sound great for active funds. “Bring on the bear market!” you can practically hear them exclaiming. Not so fast. For one thing, the odds of an active stock fund beating its index in a down market was essentially only a coin flip, which is not exactly awe-inspiring.
Putting that aside, we also have to consider that the market has risen far more often than it’s fallen historically.
More than 80% of the rolling three-year returns I measured came during an “up” market (that is, the index had a positive return over that 36-month period). And as we saw earlier, active stock funds outperform less often in up periods than down periods. That’s evident when I break the preceding chart down by the number of positive and negative excess measurements in up and down markets.
Active stock funds lagged their index 62% of the time when the market was up, compared with about half the time when it was down. What’s more, when active equity funds underperformed their benchmark in an up market, they did so by around 3.5% per year, on average, which was a wider margin than the average successful active fund’s excess return in up periods (2.9% annually).
Consequently, the average active stock fund lagged its benchmark by 1.1% per year over all rolling 36-month “up” periods I measured, while it beat its index by a lesser 0.3% per year over all rolling three-year “down” periods. Since there were so many more up periods than down periods, this explains why the average active equity fund underperformed its benchmark by 0.8% per year over all—that is, up and down—rolling 36-month periods.
Conclusion
Unlike the “stock-pickers market” fallacy, there’s a kernel of truth to the notion that active stock funds hold up better versus their indexes in down markets. They outperformed more often when their indexes were down, and furthermore, when they succeeded, they did so by a wider margin on average in down than up markets.
But that’s not the whole story. Active stock funds only had about a coin flip’s odds of succeeding in down markets. That aside, equity indexes rose far more often than they fell, and active stock funds succeeded far less frequently in rising markets. In addition, the average laggard underperformed to a greater extent in up markets than the average successful fund outperformed.
Taken together, this explains why active stock funds have so often failed to beat their benchmarks over the past 26 years, notwithstanding their relatively greater success in down markets.
Switched On
Here are other things I’m saying, reading, listening to, or watching:
- Jason Zweig on a small-town pension that got stuck in an unlisted REIT
- I chatted with my colleague Margaret Giles about key takeaways from our recently published “Mind the Gap” study; related: I also chatted with Barry Ritholtz about minimizing trading errors by automating investing
- I wrote about a nonlisted private fund-of-fund-of-fund-of-funds
- Lawyers vs. engineers: Patrick O’Shaughnessy has a fascinating chat with Dan Wang about China
- Tyler Cowen interviews Sam Altman about artificial intelligence and author Jonny Steinberg about his book on Winny and Nelson Mandela
- 1,140 square feet of nope
- A well-deserved tribute to White Stripes drummer Meg White
Don’t Be a Stranger
I love hearing from you. Have some feedback? An angle for an article? Email me at jeffrey.ptak@morningstar.com. If you’re so inclined, you can also follow me on Twitter/X at @syouth1, and I do some odds-and-ends writing on a Substack called Basis Pointing.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.
