These Funds Beat the Index By Going Full Tilt

My colleagues recently published the latest installment of Morningstar’s semiannual Active/Passive Barometer report. If you’re not familiar with it, the Barometer is a running tally of how many active funds have topped an average of passive funds in their category over various past periods. Here’s the money table from the most-recently published report.

In general, the results are sobering for active funds. The longer the time period, the lower the odds of success—and those odds are very long indeed in a number of categories.

Rattle Around

One of the things you’ll also notice is that short-term success rates rattle around. To illustrate, here’s a comparison from the report showing how many active funds topped their benchmark over the years ended June 30, 2025 and June 30, 2026.

Granted, it’s just one year. But one of the things that stood out was the way success rates improved in seven of the nine US equity categories, especially the small- and mid-cap peer groups.

What caused that?

Substance vs. Style

It appears to stem mainly from differences between the active funds’ and benchmarks’ portfolio holdings. That is, the active funds’ style differed from the passives’ and those differences worked to the funds’ advantage over the year ended June 30, 2026.

To illustrate, here’s a breakdown of the average active fund’s style exposures by

. I’ve used “Home” to denote the average weight in stocks that fell in the region matching the fund’s category (for example, the average large-growth fund’s weight in stocks that plot in the large-growth box), “Neighboring” for stocks in regions bordering the “Home” region (for example, large-blend and mid-growth neighbor large-growth), and “Other” for stocks splayed elsewhere in the style box.

It’s an interesting breakdown. The average active fund in five of the six large- and mid-cap categories has less in the “Home” style than the passive composite. That’s about what you’d expect—passive funds are usually thought to be more “style-pure” than actives, which enjoy more latitude to range around. What’s kind of surprising, though, is the average active fund in the other three categories has more exposure to the “Home” style than the passives. Why is that?

The short answer is it seems to reflect a difference between how some of the leading small-cap index funds define “small-cap” and how Morningstar defines it for style-box purposes. For instance, the $183 billion Vanguard Small-Cap Index Fund tracks a benchmark that defines small-caps as stocks that account for 85% to 98% of cumulative US stock market capitalization, whereas the style box defines it as stocks that account for 90% to 100% of US market cap. In other words, the passive composite doesn’t dip as deep into small cap as many active funds do.

Tilts and Success Rates

That quirk aside, the point is these differences can help explain why active fund success rates might have fluctuated higher or lower over a given period. To illustrate, here’s how the nine styles performed over the year ended June 30, 2026. I used the asset-weighted average return of the passive funds in each Morningstar category to proxy for each style’s return.

We can approximate the aggregate impact of an active fund’s style tilts by taking the difference between its “Home” style’s return (such as the large-growth style’s return for a large-growth fund) and the returns of other styles to which it’s exposed (large blend, mid-growth, et cetera). Then, we multiply those differences by the fund’s over- or underweighting to those styles when compared with the passive composite. Here’s an example for the average active mid-cap value fund:

In summary, the average active mid-cap value fund had heavier exposure to the small-cap styles and, correspondingly, less weight in large- and mid-caps. That was a boon to performance because small-caps outgained the passive mid-cap value average to a far greater extent than the large- and mid-cap styles did.

A simple attribution like this can yield a sense of how much benefit an active fund might have derived, or the penalty it incurred, versus the index from its style tilts. Here’s how it looked for the average active fund in all nine categories:

Active US stock funds reaped rewards from their style tilts in seven of the nine categories, with active small- and mid-cap funds deriving the most significant benefits. That largely lines up with the year-over-year changes in success rates for active funds in these categories.

Given this is just a single year-over-year comparison, I decided to expand the analysis to assess the relationship between payoffs from style tilts and changes in active-fund success rates over four additional 12-month periods: June 2021 to June 2022, June 2022 to June 2023, June 2023 to June 2024, and June 2024 to June 2025. Here’s a scatterplot showing the relationship for all nine US equity categories over the five total year-over-year periods:

It’s not a perfect fit, but the direction of success rates—higher or lower—corresponded with the payoff from style tilts more than 70% of the time. (The attribution I’ve walked through is better known as “Dunn’s Law,” a concept my former colleague John Rekenthaler has been writing about for years, most recently in this piece he wrote around a decade ago.)

Micro and Momo

Of course, the style box doesn’t tell the whole story. There are other factors besides size and valuation, or at least some dimensions the style box doesn’t break out.

Take micro-cap stocks, for instance. The style box doesn’t separately classify micro-caps. Rather, it lumps them in with all other small-caps. Thus, two funds could have similar small-cap stakes, but one might have a much larger micro-cap weighting than the other. When micro-caps and larger small-caps perform alike, that difference doesn’t matter much. But when they diverge, as they did over the year ended June 30, 2026, it can be very consequential.

(My colleague Dan Culloton recently published a nice rundown of the recent rally in micro-caps and some other factors, which you can find here.)

To assess how that affected trends in active-fund success rates, I tallied up every active US stock fund’s micro-cap weighting as of June 30, 2025, and then compared it to the micro-cap stake of the passive composite for its category. Then I assigned every active fund to a bucket based on the magnitude of its micro-cap over- or underweighting. Finally, I counted up the number of active funds in each bucket that beat the passive composite over the year ended June 30, 2026.

In summary, the more overweight an active fund was in micro-cap stocks, the likelier it was to beat its passive composite, and the opposite for active funds that were underweight.

There’s also the momentum factor to consider. Price momentum, which isn’t incorporated into two-factor style-box configuration, holds that investors derive a risk “premium” from buying stocks that have risen in price while shorting those that have fallen. Morningstar has built its own proprietary factor model and ranks each fund based on an array of factors including momentum.

Given this, I was able to compile every active US equity fund’s momentum factor ranking over the year ended June 30, 2026. Using those rankings, I assigned all of the funds to quintiles and then measured the percentage of funds in each quintile that outperformed their passive composite.

As with micro-cap stocks, the more exposure to momentum an active fund had in the 12 months ended June 30, 2026, the likelier it was to succeed, owing to the fact that momentum had a very strong year.

Taken together, these factors were very important to active US equity fund success rates over this period, as shown below.

Active US stock funds with lots of micro-cap and momentum exposure succeeded at far higher rates than the norm.

Takeaways

• Signal vs. Noise: If it’s not already clear, short-term fluctuations in active-fund success rates tell you more about holdings differences than they do manager skill. To be fair to managers who are picking stocks bottom-up in a way that aligns to a particular style, any successful payoff owes to the choices they made. But it is also hard to separate noise from signal over such short intervals, with headwinds quickly becoming tailwinds and vice versa.
• Heroes and Goats: Though the stylistic trends worked in more active funds’ favor over the year ended June 30, 2026, that doesn’t make them heroes. And by the same token, when their favored styles were out of vogue in past periods when they slumped, it didn’t mean they were goats.
• Smart or Dumb? Along those lines, it’s silly to ascribe any of these changes in short-term success rates to manager acumen. No question, fund managers are some of the most talented, highly trained, and accomplished individuals in finance. But it’s not like they flake out in one 12-month period and then come to their senses the next.
• Death to the Stockpicker’s Market: It just might be the hoariest cliché in investing circles—the stockpicker’s market. John Rekenthaler once called the adage “as common as flies at a picnic.” He was being kind. As the kids say, it’s cringe, and the industry can’t rid it from its vocabulary soon enough.

Switched On

Here are other things I’m reading, watching, and listening to:

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.