New ev­i­dence in ac­tive vs pas­sive in­vest­ment de­bate

UBS looks at the per­for­mance of funds in Europe over a 20 year pe­riod

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There is new ev­i­dence that firmly sup­ports ac­tively man­aged funds in the pas­sive ver­sus ac­tive de­bate.

In­vest­ment bank UBS has an­a­lysed the per­for­mance of more than 27,000 mu­tual funds in Europe over the past 20 years. It found ac­tive man­agers have col­lec­tively out­per­formed their bench­mark af­ter fees by av­er­age 0.42% per year since 2000.

That fig­ure rises to 0.78% out­per­for­mance per year when com­par­ing af­ter-fee re­turns to their pas­sive com­pe­ti­tion rather than bench­mark. We’ll ex­plain what all those terms mean in a sec­ond.

A RE­MINDER ABOUT THE DE­BATE A dis­pute has raged for years over which type of in­vest­ment de­liv­ers the bet­ter over­all re­turns for in­vestors: ac­tive or pas­sive?

Pas­sive in­vest­ment means buying a ve­hi­cle such as a tracker fund or ex­change-traded fund (ETF) which mir­rors the per­for­mance of a broad cross sec­tion of the mar­ket or per­haps a spe­cific in­dus­try or ge­og­ra­phy. Good ex­am­ples in­clude a FTSE 100 tracker fund or an emerg­ing mar­kets-based ETF.

Ac­tive in­vest­ment in­volves a fund man­ager hand-pick­ing stocks, bonds, prop­erty or other as­sets; with port­fo­lio weight­ings that match their in­vest­ment ob­jec­tives. The most ubiq­ui­tous styles of ac­tive man­age­ment in­clude value, qual­ity and mo­men­tum.

The aim of ac­tive man­age­ment is to out­per­form a bench­mark such as a spe­cific stock mar­ket in­dex.

FEES, FEES, FEES

One of the big­gest crit­i­cisms of ac­tive man­age­ment is the higher fees com­pared to pas­sive in­vest­ments. Sub­se­quently, there is wide­spread be­lief that pas­sive in­vest­ments equal lower costs and bet­ter per­for­mance.

Global pas­sive as­sets are set to more than dou­ble from $14trn in 2016 to $37trn by 2025, ac­cord­ing to a re­cent re­port from pro­fes­sional ser­vices firm PwC, em­pha­sis­ing their grow­ing pop­u­lar­ity.

Some in­dus­try ob­servers have even spec­u­lated on the demise of ac­tive port­fo­lio man­age­ment com­pletely.

An­a­lysts at UBS beg to dif­fer, say­ing the be­lief that ac­tive funds un­der­per­form bench­marks ‘is a myth… even af­ter fees’.

THE REAL DIS­CUS­SION

The de­bate re­ally boils down to mar­ket ef­fi­ciency. In essence, it might be de­scribed as the de­gree to which all pub­licly avail­able in­for­ma­tion is al­ready re­flected in a se­cu­rity’s price.

In the­ory, the more ef­fi­cient a given mar­ket is, the harder it is to out­per­form the sim­ple strat­egy of hold­ing a pas­sive bas­ket of all the se­cu­ri­ties in it.

But while the mar­ket may be com­pletely ef­fi­cient some of the time, and rea­son­ably ef­fi­cient most of the time, it isn’t com­pletely ef­fi­cient all of

the time as mar­ket struc­ture and par­tic­i­pant sup­ply/de­mand char­ac­ter­is­tics change.

It is on these some­time in­ef­fi­cien­cies that ac­tive man­agers hope to cap­i­talise. One way of do­ing this is to spe­cialise and be­come a rel­a­tive ex­pert in a niche. Many fund man­agers do this by con­cen­trat­ing on a par­tic­u­lar sec­tor, ge­og­ra­phy or style.

Pri­vate in­vestors of­ten do this too, typ­i­cally con­cen­trat­ing on smaller com­pa­nies, where pro­fes­sional re­search is lim­ited. Some stocks are priced in­cor­rectly be­cause most in­vestors don’t know these com­pa­nies ex­ist or don’t prop­erly un­der­stand the story.

The UBS re­port com­ments: ‘We found more fo­cused and spe­cialised funds are more likely, as a group, to gen­er­ate al­pha.’ Al­pha de­scribes the ex­cess re­turns of a fund rel­a­tive to the re­turn of a bench­mark in­dex.

MOV­ING THE DIS­CUS­SION ON

On the sur­face, it would seem that in­vestors are mi­grat­ing to­ward pas­sive strate­gies. Yet in­vestors are in­creas­ingly us­ing

both ac­tive and pas­sive prod­ucts as tac­ti­cal bets. This might be to pro­vide hedg­ing, gain from sec­tor ro­ta­tion strate­gies or boost a port­fo­lio’s ex­po­sure to emerg­ing mar­kets, for ex­am­ple.

‘It is im­por­tant to re­mem­ber that in a ris­ing mar­ket pas­sive re­turns are very at­trac­tive at low cost but that in­evitable mar­ket cor­rec­tions will bring a con­tin­ued ap­pre­ci­a­tion for the value of ac­tive in­vest­ments,’ says PwC’s Ol­wyn Alexan­der, leader of its global as­set and wealth man­age­ment team.

‘Both will be key build­ing blocks in bal­anced port­fo­lios to meet spe­cific in­vestor out­comes.’

We don’t ex­pect ar­gu­ments over pas­sive or ac­tive in­vest­ment to stop any­time soon. But per­haps a more pro­duc­tive de­bate for in­vestors would be de­cid­ing how much of your op­ti­mal port­fo­lio should be in ac­tive or pas­sive in­vest­ments. (SF)

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