The answer depends on the fee differential you're paying.
An active fund justifies its fees when: [4]
$$IR \cdot TE > \text{Fee differential vs. passive benchmark}$$
Example 1: Large-cap
A realistic large-cap IR is around 0.2 with Tracking Error — definition">tracking error of 4%. Expected alpha: $0.2 \times 4 = 0.8\%$. This falls short of the 1.1% fee hurdle — the index fund wins. [4]
Example 2: Mid-cap
If the fund has IR of 0.6 with TE of 6%, expected alpha is $0.6 \times 6 = 3.6\%$. After the 0.8% fee differential, you gain ~2.8% annually. Worth it. [4]
| IR | Assessment | Sufficient? |
|---|---|---|
| < 0.3 | Barely justifies fees | Only if fee differential is minimal (<0.3%) |
| 0.3–0.5 | Moderate skill | Justifies low-fee active funds (0.4–0.6% TER) |
| 0.5–0.8 | Good, consistent skill | Justifies standard active fees (0.8–1.0% TER) |
| > 0.8 | Excellent (rare) | Justifies premium fees |