Envestnet | PMC is an industry pioneer in blending the two opposing investment styles: active and passive. We have been implementing this approach within client portfolios well before the asset flow dominance into passive vehicles in recent years. We leverage Envestnet | PMC’s core competencies of manager research and due diligence, manager selection, asset allocation, and active/passive research to engage with our clients. We know active management is cyclical, but we are firm advocates of active strategies. We recognize the benefits of passive investing, too.
Market overview
Artificial Intelligence (AI) companies dominated equity markets in 2024, leaving other sectors trailing behind, and the final quarter of the year was no exception. After a shaky start in October, markets surged in November, fueled by the clarity of the U.S. election results and robust economic data. Major U.S. equity indices, including the S&P 500 and Russell 2000, soared to record highs. The rally was broad, with small-cap stocks gaining momentum on hopes of reduced regulation and higher tariffs, though large-cap growth stocks reclaimed leadership by year-end. Domestic equities significantly outpaced international markets, which grappled with a strengthening dollar and trade tensions, ending the quarter in red. The U.S. economy demonstrated remarkable resilience in the fourth quarter. Key indicators such as a 3.1% annualized Q3 GDP growth rate and steady payroll gains underscored the strength of consumer spending and the labor market. While the unemployment rate inched up to 4.2% in December, job openings remained abundant. Inflation maintained its downward trajectory, with the Consumer Price Index easing to 2.7% year-over-year. This allowed the Federal Reserve to lower interest rates twice during the quarter, cutting a total of 50 basis points. However, the Fed signaled caution for 2025, slowing the pace of rate cuts due to the economy's solid footing and persistent core inflation pressures. Fixed income markets faced volatility as interest rates climbed during the quarter. The 10-year U.S. Treasury yield rose from 3.81% at the end of September to 4.58% by year-end, marking a 63-basis-point increase for the year. The yield curve experienced a slight steepening, shifting from its relatively flat stance at the close of the third quarter. Rate-sensitive sectors, such as long-term Treasuries, faced significant headwinds, while high-yield bonds held steady, reflecting their stronger correlation with equity market performance. Meanwhile, gold and Bitcoin achieved new milestones, fueled by heightened demand and economic uncertainty. Bitcoin surged past $100,000 for the first time following the approval of spot Bitcoin ETFs, while gold gained 27.5%, driven by safe-haven demand. Despite the volatility across various asset classes, 2024 concluded as a remarkable year for financial markets.
Our scorecard
Our ActivePassive Scorecard shows active funds beating their category benchmarks in 11 of the 19 asset classes we tracked for the fourth quarter. In 2024, active funds led their category benchmarks in 7 of these analyzed asset classes.
The fourth quarter was a far more successful period for active managers than Q3. In Q4, managers topped our category benchmarks in 58% of the asset classes we track. In 2024 overall, however, active managers struggled to outpace their passive peers. For 2024, only one-third of the asset classes for this scorecard outperformed on the year. Let us delve into the details of our findings.
U.S. Equity
| Active Fund Category | Qtr Return | Vs. Benchmark | TTM Return | Vs. Benchmark |
|---|---|---|---|---|
| Large Cap Core | 1.30% | -1.45% | 20.90% | -3.61% |
| Large Cap Growth | 5.45% | -1.62% | 29.02% | -4.34% |
| Large Cap Value | -1.55% | 0.44% | 14.09% | -0.28% |
| Mid Cap Core | -0.32% | -0.94% | 14.07% | -1.27% |
| Mid Cap Growth | 3.52% | -4.60% | 16.20% | -5.91% |
| Mid Cap Value | -1.46% | 0.28% | 11.17% | -1.90% |
| Small Cap Core | -0.16% | -0.49% | 11.34% | -0.20% |
| Small Cap Growth | 1.86% | 0.15% | 15.48% | 0.32% |
| Small Cap Value | 0.05% | 1.11% | 9.16% | 1.10% |
Data from Morningstar as of 12/31/2024. The Morningstar US Active Fund categories used in this analysis represent US-domiciled mutual funds and exchange-traded funds classified as actively managed by Morningstar. The asset classes are represented by (in order of table): Russell 1000 TR USD, Russell 1000 Growth TR USD, Russell 1000 Value TR USD, Russell Mid Cap TR USD, Russell Mid Cap Growth TR USD, Russell Mid Cap Value TR USD, Russell 2000 TR USD, Russell 2000 Growth TR USD, and Russell 2000 Value TR USD.
Actively managed U.S. equity funds rebounded in their relative performance during Q4. After struggling in Q3, active managers enjoyed greater success this quarter while navigating a volatile period. Notably, value managers in the large, mid, and small cap asset classes collectively outperformed their benchmarks. Small cap growth strategies also turned in solid results to end 2024. Still, Q4 was a rollercoaster ride for U.S. equity investors. Small caps initially bounced when Trump won the election in November, but the Fed pummeled this asset class a few weeks later by reducing projections for 2025 interest rate cuts. (Recall that smaller firms are more sensitive to interest rate fluctuations.) Macroeconomic and industry factors also affected which large cap value niche performed best during Q4 and 2024 overall.
Large and, especially, mid cap growth funds struggled once again in Q4. Particularly in 2024, many of the largest tech names (or anything tied to AI-mania) in the Russell Mid Cap Growth Index were the best-performing names. AppLovin (APP) was up around 800% in 2024. Palantir (PLTR) was up nearly 400% and constituted a very large weight in the index. CrowdStrike (CRWD) was up nearly 100% in August-December after a significant dip tied to the IT outages on July 19, 2024. (This stock also constitutes a very large weight within the index). Many mid cap growth managers were uncomfortable loading up on these stocks due to their lofty valuations, hence the widespread active management underperformance in the category.
There is a partial regulatory explanation for the large cap growth underperformance, though. As noted by Morningstar, “The Investment Company Act of 1940 implies that an allocation of 5% or more to a single security is uncomfortably large; to earn the diversified status, a mutual fund must limit the aggregate share of such positions to 25% of its assets.” This position limit restriction has also been especially relevant to large cap growth managers operating in a highly concentrated market. As of 12/31/2024, the Russell 1000 Growth’s five largest constituents accounted for nearly 45% of the index’s weights. Active large growth stock managers cannot accumulate such large holdings without falling into a different regulatory category with somewhat negative connotations. Mid cap growth managers, however, do not face this type of benchmark weighting concentration.
For 2024, only small cap growth and value managers delivered aggregate outperformance. Large cap and mid cap growth managers were the year’s laggards from the relative performance versus benchmark perspective. Of note, the three equity fund asset classes with the highest absolute returns for 2024 also saw the greatest active management underperformance.
Non-U.S. Equity
| Active Fund Category | Qtr Return | Vs. Benchmark | TTM Return | Vs. Benchmark |
|---|---|---|---|---|
| Developed Markets | -7.31% | 0.80% | 4.92% | 1.10% |
| Emerging Markets | -6.81% | 1.20% | 5.77% | -1.73% |
Data from Morningstar as of 12/31/2024. The Morningstar US Active Fund categories used in this analysis represent US-domiciled mutual funds and exchange-traded funds classified as actively managed by Morningstar. The asset classes are represented by (in the order of table): MSCI EAFE NR USD and MSCI EM NR USD.
Turning to non-U.S. equity markets, both developed and emerging market fund managers delivered aggregate outperformance in Q4, despite the widespread losses in these asset classes. The U.S. election results impacted overseas markets in a negative manner, sending the MSCI EAFE index of developed markets sliding 8.1% for the quarter. The MSCI Emerging Markets index also dropped 8% in Q4. This type of international stock volatility is far from unprecedented, though, and active international fund managers collectively reduced losses compared to our benchmarks.
Looking at all of 2024, we see more mixed results. While developed markets managers provided solid outperformance, emerging markets managers fell behind our benchmark. The often-underwhelming returns from China, except for a relatively brief period in September and October, created a challenging landscape for emerging markets last year. Developed markets managers had to contend with the fallout from numerous elections in 2024, however they still delivered excess returns as a group.
Fixed Income
| Active Fund Category | Qtr Return | Vs. Benchmark | TTM Return | Vs. Benchmark |
|---|---|---|---|---|
| Intermediate Bond | -2.85% | 0.21% | 1.72% | 0.47% |
| Short-Term Bond | -0.04% | -0.02% | 5.15% | 0.76% |
| Intermediate Muni | -1.02% | 0.02% | 1.96% | 0.80% |
| High Yield | 0.33% | 0.15% | 7.67% | -0.52% |
Data from Morningstar as of 12/31/2024. The Morningstar US Active Fund categories used in this analysis represent US-domiciled mutual funds and exchange-traded funds classified as actively managed by Morningstar. The asset classes are represented by (in order of table): Bloomberg US Agg Bond TR USD, Bloomberg US Agg 1-3 Yr TR USD, and Bloomberg Municipal 5 Yr 4-6 TR USD, Bloomberg US Corporate High Yield TR USD.
Active fixed income managers performed well overall in Q4, largely continuing their outperformance through 2024. Fed Chairman Powell and company sent bonds slipping downhill in Q4, except for high yield securities. US intermediate-term bonds fell 3.06% for the quarter, making them the biggest loser of the major fixed income categories. Overall, U.S. bonds fell toward the end of 2024, with a weak December capping a year of lackluster returns for this asset class. Despite this difficult environment, active bond managers bested ¾ of our asset class benchmarks for the quarter. In the fourth category, short-term bond fund managers only trailed by a trivial two basis points.
When considering returns for all of 2024, active bond managers also generated collective outperformance in ¾ of the fixed income asset classes tracked for this scorecard. Only high yield fund managers underperformed our benchmark during 2024. Due to the construction of many major bond indices, active managers may have more opportunities to provide excess returns. Unlike the highly concentrated large cap growth environment discussed earlier, fixed income managers typically have highly diversified benchmarks that can be easier to beat. Many active taxable bond managers tend to have an overweight to corporate credit given solid fundamental valuations, but they have grown a little weary based on historically tight spreads, meaning the yield differential between bonds with higher and lower credit ratings. This environment has translated into many trimming this exposure across the board (whether it be in investment grade or high yield) and shifting capital into securitized products (like mortgages).
Diversifying Asset Classes
| Active Fund Category | Qtr Return | Vs. Benchmark | TTM Return | Vs. Benchmark |
|---|---|---|---|---|
| Commodities | -0.43% | 0.02% | 5.15% | -0.23% |
| Real Estate | -6.47% | -0.53% | 6.75% | -1.35% |
| TIPS | -2.29% | 0.59% | 2.34% | 0.50% |
| Bank Loan | 2.17% | -0.09% | 8.43% | -0.53% |
Data from Morningstar as of 12/31/2024. The Morningstar US Active Fund categories used in this analysis represent US-domiciled mutual funds and exchange-traded funds classified as actively managed by Morningstar. The asset classes are represented by (in order of table): Bloomberg Commodity TR USD, DJ US Select REIT TR USD, BBgBarc US Treasury US TIPS TR USD, and Morningstar LSTA LL TR USD.
Finally, let’s delve into our unique diversifying asset classes. We see mixed Q4 results for these investment categories, with commodities and TIPS (Treasury Inflation-Protected Securities) active managers topping our benchmarks. Real estate and bank loan managers underperformed, though. ¾ of these asset classes lost ground in the quarter, too. The culprit for much of these losses was the Federal Reserve. By dampening hopes for significant 2025 rate cuts due to stubborn inflation, the Fed disappointed most investors. Note that bank loans referenced in our scorecard above are typically floating interest rate products, so this asset class was supported by the Fed’s projection for higher rates in 2025.
For 2024, only TIPS fund managers delivered aggregate outperformance. This success occurred even though inflation declined for much of last year before progress stalled toward the end of 2024. Real estate has historically been harmed by the higher interest rates that the Fed now forecasts for 2025, but commodities have generally performed well when inflation is higher. These diversifying asset classes thus have divergent exposures to interest rates and inflation.
Factor update
Below, we examine the performance of the five key factors (described by the infographic) in the current market environment.
These indices represent US factor returns: MSCI USA Enhanced Value, MSCI USA Momentum, MSCI USA Minimum Volatility, MSCI USA Quality, MSCI USA Small Cap, and MSCI USA GR USD. As of 12/31/2024. Data source: Morningstar.
- Q4 saw mixed factor performance, but the general Market factor led the way. In another unusual result for a volatile period, the Minimum Volatility factor was nearly the worst performer for the quarter.
- The Value and Quality factors also lagged in the quarter as growth stocks and somewhat riskier companies led the way in Q4. (Recall that the Quality factor is tied to solid profitability and fundamentally strong balance sheets.)
- The Momentum factor performed relatively well in the quarter as large cap growth stocks continued to largely outperform. While small cap stocks experienced a seesaw end to the year (up in November but down in December), the Size factor ultimately eked out a small gain.
- For 2024 as a whole, Momentum was the only factor that beat the Market factor, although Quality also performed well. The Value and Size factors were the 2024 laggards, though, as the market continued to be led by large cap growth stocks.
- We continue to believe in factor diversification for portfolios because no single factor excels in every market environment.
The power of both active and passive management
This update on active and passive management covers a relatively short timeframe, but Envestnet | PMC has a long history of research and portfolio management using our ActivePassive methodology. This framework requires patience and a deep understanding of cyclical trends. Ultimately, though, we believe there is a place and a time for both active and passive management.
For more information on Envestnet | PMC, please visit www.investpmc.com
