Active vs Passive investing

As the market commentary this month highlights, the usually quiet summer months have been unusually volatile. Markets have been up and down like a roller-coaster.

While we very much advocate investors have a long-term time horizon and try to ignore market wobbles like this, another thing that was been highlighted in the past few months is the difference a good actively managed fund can make to your portfolio.

But before we get into the nitty gritty, here’s a reminder of what passive and active funds are.

Passive funds

Passive funds track an index (such as the FTSE 100), investing the same proportion of money in the constituent companies. By definition a tracker will never beat the market and will always underperform due to running costs. The only other guarantee that comes with trackers is that the investor is exposed to the full volatility of the market.

Active funds

Active funds and fund managers aim to outperform their index. The fund manager will research the market to identify and invest only in those companies that, in their opinion, are likely to outperform. He or she may not be right but, at the very least, investors have a fighting chance of getting a return above the market. The fund manager is not forced to stay invested at all times, nor do they have to buy expensive companies just because they are in the index. Therefore a good fund manager has the potential to protect you in a falling market.

A few facts

Fact number one: we invest in equities because, on a long-term basis, they offer the best opportunity for the highest returns. Fact number two: we all love the prospect of the returns available from equities, hate losing money, and would like to do away with volatility in equities or at least reduce it. On this basis, then, I find it extremely difficult to find a reason for investing in trackers.

The only occasion when passive investing would work is if markets were efficient, in which case we would all believe in the “Efficient Markets Hypothesis”, an academic theory which states that it is impossible to beat the market because stock market efficiency causes existing share prices to reflect all available information.

If that were true then we would not have managers such as Adrian Frost, Angus Tulloch, Neil Woodford and Warren Buffet, to name but a few. All these managers have massively outperformed their respective markets on a long-term basis. At FundCalibre we pride ourselves in identifying and rating only these types of managers whom have consistently produced, and are capable of producing, market-beating returns.

The recent sell-off

Many active managers have also been less risky than the market. This has been particularly apparent during the recent sell-off. The FTSE 100 has lost 13.61% since it peaked on April 27th but the average UK Equity Income fund lost just 6.40% after all fees. CF Woodford Equity Income fund lost just 1.31%.* This really highlights how an active manager can protect you whilst a tracker will do no such thing.

The information below shows the 10-year performance and risk profiles of some of the better known passive funds versus some of our Elite Rated funds.

FTSE 100 index total return Total Return: 64.47% Volatility: 18.72%

FTSE All Share total return Total Return: 77.91% Volatility: 18.36%

Passives:

Halifax UK FTSE 100 C Total Return: 36.65% Volatility: 17.82%

Halifax UK All Share C Total Return: 52.61% Volatility: 18.36%

Marks & Spencer UK 100 Comp Total Return: 47.92% Volatility: 17.04%

Actives:

Liontrust Macro UK Growth Total Return: 103.99% Volatility: 15.19%

Artemis Income Total Return: 96.34% Volatility: 14.27%

Trackers do provide an ideal opportunity to capture market movement tactically (that is short term) and may cost less to run, but as for making real money long term, well we will always be investing in active funds.

* 27 April 2015 to 4 September 2015
** 2 September 2005 to 2 September 2015
*** 3 September 2005 to 28 August 2015

Data source: FE Analytics Pro

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views of the author and any people interviewed are their own and do not constitute financial advice.