The Art of Wealth Management – Active vs Passive Funds

In a bid to demystify Wealth Management (we are on a mission to democratize Wealth Management, but more on that later), we are beginning this series, The Art of Wealth Management. First up, we dig into Active vs Passive Funds with Hamilton Financial head honcho Andrew.

There are about 3,000 unit trusts and 394 investment trusts in the UK, all actively managed. Despite this huge choice, many wealth managers choose instead to use index (or passive) funds, which are designed simply to track or replicate an index such as the FTSE 100.  This is largely for two reasons.

1. Index tracker funds are usually less expensive than actively managed funds. For example, the total cost of a Vanguard index fund ranges between 0.25% and 0.72%. (Vanguard manage about $3 trillion inside their various offerings) Compare this with the Baillie Gifford’s flagship fund, Scottish Mortgage Investment Trust whose total costs amount to 0.82% or Capital Gearing Investment Trust at 1.13%.
2. What I call the 75/25 excuse for avoiding actively managed funds. The 75/25 excuse goes like this: “Why use expensive actively managed funds when 75% of them fail to beat their sector index?” (Vanguard have a rather seductive strapline, “Don’t look for the needle in the Haystack. Just buy the Haystack!”)

Let’s deal with the costs first. Costs are, of course, important and they can certainly impact adversely on investment performance. But, to look at them in isolation of performance is muddled thinking. Which Oscar Wilde character said of another, “ They know the price of everything and the value of nothing?” ( We have all paid the price at one time or another for buying the cheapest!) Costs are a factor, but they are by no means conclusive.

Now let’s look at the 75%/25% excuse. Any Wealth Manager who uses this argument to exclude actively managed funds from client portfolios is simply not trying! What is to stop them from using one of the endless research tools available to find the funds which, over a longish period of time – 5 years or more – consistently beat their index fund counterparts? It may sound obvious, but clients who pay advice fees to Wealth Managers for filling up their portfolios with tracker funds should ask themselves “why and what for?”.

Where is the evidence?

Given that Passive Funds are very big business, is there any good evidence to challenge their popularity? Google – which benefits hugely from Passive advertising – was no help at all.  It was only thanks to a friend that I found the evidence I was looking for.  You can find more analysis of the study at Citywire. We also have a PDF of the actual study that we would be happy to share. Please email us if you would like it.

In March 2017, Fund Consultants LLC, an American company, was commissioned to conduct a study into the merits of Active v Passives. They compared the returns of 500 Investment Trusts against the returns of 1500 Exchange Traded Funds (ETFs), choosing this category of passive since they have a relatively stable asset base. “Comparing their respective Net Asset Value (NAV) total returns net of expenses, 53% of Investment Trusts outperformed  their  ETF equivalents over 1 year, 76% over 3 & 5 years and an outstanding 90% over 10 years. Similar results applied to share price performance.” They were able to conclude. “Therefore, we believe that the lower expense argument for passively managed funds should be finally put to bed as it takes no account whatsoever of the associated returns…………and as both sets of returns are quoted net of costs, it is the returns not the costs that investors should be focused on.”

Conclusion

Before I conclude, a cavaet. Some people just feel psychologically more comfortable using passive funds – and there is no doubt that most of them are less costly. But as we have seen, costs are not  everything. For those who are braver, my advice is to find a Wealth Manager who specialises in using actively managed funds, particularly the closed ended version, Investment Trusts. The evidence is compelling. It shows that over time, actively managed funds deliver investment returns which are superior to their passive counterparts.

Andrew Hamilton, February 2021

Managing Director

Hamilton Financial

Financial Advice | Investment Management

DISCLAIMER:

The information contained in this document is for guidance only and does not constitute advice which should be sought before taking any action or inaction. The value of investments can fall as well as rise. You may not get back what you invest.