There has been an ongoing debate for many years on the relative merits of active versus passive investment approaches. For a long time, active has been favoured but passive is growing in popularity. According to Morningstar, and reported in the Financial Times, assets managed in passive funds have grown 230% since 2007, reaching a total of $6 trillion. This growth is four times faster than active products over the same period.
The big question used to be: which is better? But should you favour one over the other, or use both? In the current environment of relatively low returns, investors should be looking at every possible way of generating the best performance (net of charges) from their portfolios.
First, some definitions:
The views expressed in this section are those of the fund managers and not those of TD Direct Investing.
Exchange Traded Products (ETPs) including ETFs, ETCs and ETNs track a wide variety of underlying investments, some of which may be complex in nature and involve leverage, shorting or a high degree of volatility. It is therefore important that you read the Prospectus or Fact Sheet (available on the issuers’ websites) prior to investing and ensure that you understand how it is structured and the associated risks.
We think there is room for both, and the best approach for investors is actually to take the best parts of each and include them in their portfolio – not active versus passive but active and passive.
There is still definitely a place for active fund managers who are able to demonstrate consistent skill over the long term. Even major player in the passive world BlackRock, which has the largest Exchange Traded Fund (ETF) business in the world, recently hired a new head of global active equity, and Robert Kapito, president at BlackRock, believes active funds will offer investors a chance of outperformance. He says: “In a lower return environment, incremental gains from active management have a stronger impact on performance.”
The challenge for investors is how to select the right active managers to fit a certain investment strategy. Our Recommended Funds list is one way of identifying strong active managers with consistent track records across a broad range of asset classes.
Here in the UK we often take our lead from what is happening in the US, and the landscape there is changing dramatically for active managers. While a few active US equity fund managers have been able to outperform the US stock market on a consistent basis, the majority don’t, which is why passive is becoming more popular.
This is due in part to the fact the US market is the most efficient in the world. The vast majority of companies, aside from a number of micro caps, are well researched. This makes it extremely difficult to discover and act on information about a company which is not already in the public domain.
While in the UK a higher number of active fund managers beat their benchmarks, relatively few do it on a consistent basis. And the question of charges is becoming ever more important, particularly during a period of low returns.
So how are active managers going to respond? They’re looking for ways to become more competitive on fees, so they can compete with the lower cost, passive, alternatives and outperform their benchmarks. Another trend is the rise of active managers becoming more opportunistic and less rigid in terms of following an investment style.
Meanwhile, investors are increasingly turning to passive solutions. Ben Johnson, who researches passive investments for Morningstar, notes an increase in ETF usage in the US market, with passive funds due to take more than 50% market share within the next year or two. In the UK, there has been a noticeable uptick in the adoption of tracker funds and ETFs, with companies such as Vanguard, BlackRock and ETF Securities taking significant market share.
Some investors are already adopting a passive approach to access certain markets. While these investors are no longer making stock selection decisions they are required to make asset allocation decisions. For example in 2015 the FTSE All Share index returned 1% while the FTSE 250 achieved 11%. Are you experienced and qualified enough to make the decision on which to invest in? How do you go about monitoring and rebalancing your portfolio?
All this means you are still effectively taking an active approach to manage your passive portfolio. An approach such as that taken by Vanguard, Blackrock and several others, where the asset allocation is done for you, could be appropriate for some investors.
Bill McNabb, chief executive officer of Vanguard, one of the major global players in the passive investment space, agrees. He believes investors should “buy the market” via passive products such as exchange traded funds (ETFs), then use active funds as satellite positions around them. Vanguard offers a range of passive LifeStrategy funds which are intended to be used as low cost core building blocks for a portfolio (the ongoing charge on the Vanguard LifeStrategy Growth Fund, for example, is 0.24%). For us this approach makes a lot of sense. The central part of your portfolio can be formed using a low cost passive strategy, and depending on your risk profile you can add some active fund exposure.
Source: Morningstar, as at 22 June 2016
Figures from BlackRock show $10.7 billion of assets flowed into exchange trade products (ETPs) globally in May this year. Year-to-date (to the end of May) that figure is $93.4 billion (note that the assets chart above shows total assets minus outflows and performance growth). These are significant numbers and highlight just how popular passive strategies are becoming. These include smart and strategic beta, which refer to strategies which use alternative ways of building indices to the traditional market capitalisation weighted approach.
"A more diversified set of investors have a better understanding and a more positive stance towards ETFs than in the past,” says Matthew Tucker, head of iShares US fixed income strategy at BlackRock. “This is happening across asset classes and across geographies. However, the biggest challenge of the growth of ETFs is how to increase education and awareness."
|The pros...||...and the cons|
|The pros...||...and the cons|
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