A recent MorningstarA article reports the results of a study conducted on a theory known as Dunn’s Law, which suggests that active managers sometimes outperform indexes due to stylistic differences in their portfolios (using data from the Morningstar Active/Passive Barometer for 12 categories):

The firm set up regression models that could test, for example, “if active managers in the large-value category have greater exposure to mid-cap value stocks than their index peers, their success rates should improve when smaller stocks beat larger stocks. The regression would detect that relationship.”

For the nine U.S. equity categories, the article explains, the variables used included market risk, small size, value, and international. Results (1-,3-, and 5- year periods) are illustrated as follows:

The study results, the article says, “demonstrate that differences in investment style between active and index funds can help explain the variation in success rates. However, the data did not follow all the predictions of Dunn’s Law.”

It concludes that, “just as it is difficult to predict when the market will do well, it is difficult to predict when certain investment styles will be in favor. So, it’s best to accept that active managers’ success rates will be volatile and not try to time exposure between active and passive funds.”