The Paradox of Low-Cost Active Management: Cost Efficiency vs. Performance Durability

The debate between active and passive investing has long centered on the tension between cost efficiency and performance durability. Recent evidence, however, paints a nuanced picture of actively managed funds with paper-thin expense ratios-suggesting that while cost reductions improve their odds of outperformance, they remain unlikely to consistently rival passive strategies over the long term.

According to a Morningstar report, only 13.4% of China's stock-heavy active funds outperformed passive peers in 2024, a decline from prior years. Similarly, European equity active managers achieved a one-year success rate of 29.0% in June 2025, but only 4.7% outperformed over a 10-year horizon. These figures underscore a persistent challenge: even low-expense active funds struggle to generate durable alpha in highly efficient markets. The SPIVA U.S. Scorecard reinforces this trend, noting in an Accountend analysis that 85% of large-cap active funds underperformed the S&P 500 over five years, and 90% did so over ten years.

Cost efficiency, however, remains a critical variable. Morningstar data reveals a clear link between lower fees and higher odds of outperformance. For instance, over 30 years, an active fund with a 1% expense ratio yields significantly lower returns than a passive fund with a 0.05% ratio, even assuming identical pre-fee returns. This compounding drag from fees explains why 57% of active funds underperformed sector averages over five years, compared to 40% of passive funds, according to a Yodelar comparison. Yet, as Nanigian's research highlights, active funds with expense ratios closer to passive benchmarks tend to perform better, suggesting that cost discipline can enhance, but not guarantee, success.

Exceptions exist in less efficient markets. In China's small- and mid-cap equities, 38.2% of active managers outperformed passive peers in 2024, while European government bond funds achieved a one-year success rate of 69.8% in June 2025. These cases illustrate that active management can add value where mispricings persist and where skilled managers exploit niche opportunities. However, such successes are localized and inconsistent, failing to offset broader underperformance in large-cap or global equity markets.

The role of cost efficiency extends beyond fees. Active funds are often more tax-inefficient due to higher turnover, further eroding net returns. Meanwhile, passive strategies benefit from scale and simplicity, reinforcing their appeal to long-term investors; as noted in a ScienceDirect study, passive funds have captured significant market share globally driven by their cost advantages and performance consistency.

For investors, the implications are clear: while low-expense active funds may offer marginal improvements over traditional active strategies, they remain secondary to passive options in most asset classes. Active management retains a niche role in inefficient markets or specialized sectors, but its broader durability is limited by structural challenges. As markets grow more competitive and transparent, the pressure on active managers to justify fees through performance will intensify-a challenge few can meet.