Active or Passive Fund management – which is better?
” active or passive fund management better – Austen Robilliard Head of Investment gives his view”
The Active versus Passive fund management debate continues to rage amongst industry professional and private investors alike and with no end in sight. Active proponents readily cite Warren Buffett, Anthony Bolton and Terry Smith as proof it can deliver out-performance over time. Passive supporters now add Neil Woodford’s catastrophic demise to their counterargument with high charges, questionable performance and risk of serious under-performance.
Tracking strategies will generally under-perform their chosen index due to charges. The higher the cost the worse the outcome and there are also some technical issues with how they replicate the Index. The use of derivatives and stock-lending can impact too. Returns from actively managed funds range from dreadful to fantastic and anywhere in between.
I started as a collective investment analyst just as the Global Financial Crisis bear market hit in July 2007. In many ways, a baptism of fire but I would argue in some ways perfect timing. One saw first-hand and graphically the wheat being separated from the chaff, and the perils of not fully understanding in what you are actually invested.
I head up our investment team now and train the next generation of fund selectors. I remain diligently involved in the fundamental investment research on a daily basis. There is no substitute for being at the coal face. Over time I have researched active mandates, tracking strategies, hedge funds, quantitative and macro-economic vehicles, thematic plays and more. Of the multiplicity of systems available I always come back to the same conclusion.
For the avoidance of any doubt, I sit resolutely in the active management arena. I commend it but only if you are committed to the challenge of selecting and continually monitoring the managers you choose within your portfolio. One adds value to a portfolio by finding managers who can potentially deliver consistent alpha compounding excess returns over time.
There is no budging the two polarized sides of the dispute regardless of evidence or examples quoted. Others believe there is merit in combining both systems – but not me. You may already have decided your stance or maybe open to evolving your style, so I want to highlight some potential pitfalls you face:
Combining active and passive funds:
Alpha is the excess return above a benchmark delivered by a manager’s skill. It is easier to find in some asset classes, so why not have passive funds where alpha is trickier to find? Alpha might be hard to come by but expending that extra resource in finding it should pay dividends in the long run. If you believe active managers can outperform, then buy active funds. If not, then stick to passive funds. A central investment philosophy is vital to keep the portfolio focused and easier to analyse whether the objectives are being met.
Portfolios often hold multiple funds in the same asset class, which is sensible if done correctly. A real detractor if not! If your funds are exposed to the same themes, do their holdings overlap and are their investment styles too similar? They will tend to go up together and down too. Duplication lowers the real benefit of diversification and makes the portfolio more susceptible to shocks in those areas.
- As investment themes play out it is tempting to buy in to the funds who have recently performed well and sell out of those lagging behind. You need to be prepared to tolerate poor performance in an unloved area. Choose managers you are confident in and who can clearly justify their positioning at any given time.
- You shouldn’t have too much money in one fund or holding. We often see an extensive list of holdings in a portfolio, sometimes with as little as 0.3% to a fund. Diversification is intended to tackle the risk on fund severely damaging your performance. But even if it is a brilliant choice, out-performing by 20%, it only adds 0.06% to performance. If you have conviction in a manager, the weighting should be meaningful. For me, setting a minimum allocation level is just as important as having a maximum weighting:
Trackers reduce the risk of significant under-performance and require little intervention once set to match your risk tolerance and investment aims. If you are diligent and have a robust active investment process, you can deliver above average performance over the longer-term.
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