FEA­TURE

A falling mar­ket may war­rant turn­ing to the skills of fund man­agers

Shares - - CONTENTS - By Laura Suter AJ Bell Per­sonal Fi­nance An­a­lyst

Pas­sive funds on the rise – but is it time for ac­tive?

The use of pas­sive funds has been in­creas­ing for years, with in­vestors drawn to their sim­plic­ity and low cost. But are they the right in­vest­ment for all mar­kets, and what hap­pens if a mar­ket dip is on its way?

Pas­sive in­vest­ments track an in­dex or mar­ket, such as the FTSE 100 in­dex of lead­ing UK com­pa­nies, and will repli­cate the per­for­mance of that mar­ket.

It will never out­per­form the mar­ket and will fol­low it up as well as down. This means if the FTSE 100 rises by 5%, so too will your in­vest­ment, but like­wise if it falls by 5%, your in­vest­ment pot will fall by the same amount.

Be­cause there is no fund man­ager run­ning the money and pick­ing stocks, as there is with ac­tive funds, pas­sive in­vest­ments are typ­i­cally cheaper. What’s more, as pas­sive funds have grown in size they have passed on cost sav­ings to in­vestors. Our

re­cent ar­ti­cle showed that the cheapest ex­change-traded funds, a form of pas­sive in­vest­ment, charge just 0.04% – which is 40p for every £1,000 in­vested.

WHY ARE THEY SO POP­U­LAR?

In­vestors are flock­ing to pas­sive in­vest­ments at the mo­ment. The most re­cent fig­ures from in­dus­try trade body the In­vest­ment As­so­ci­a­tion, which tracks where UK in­vestors are putting their money, shows that they al­lo­cated £1bn to tracker funds in Septem­ber.

This is re­mark­able when the net sales for all funds that month were just £642m (the fig­ures col­late in­flows and out­flows, with other fund types see­ing a net out­flow).

Tracker funds now rep­re­sent 15% of the to­tal fund mar­ket to­day, com­pared to 6% a decade ago, ac­cord­ing to the In­vest­ment As­so­ci­a­tion data, and there is now £195bn of money in­vested in them in to­tal.

The lat­est fig­ures from AJ Bell YouIn­vest on the most pop­u­lar funds in Oc­to­ber show this trend clearly.

Among the top 15 in­vest­ments were a healthy dose of pas­sive funds. This was split be­tween pure track­ers and pas­sive port­fo­lios that al­lo­cate money across a num­ber of dif­fer­ent as­set types and stocks mar­kets, such as AJ Bell’s own pas­sive funds and Van­guard’s LifeS­trat­egy funds – each of which have a range of dif­fer­ent funds with vary­ing al­lo­ca­tions to dif­fer­ent coun­tries’ stock mar­kets, bonds and cash.

An­other large chunk of the most pop­u­lar funds was in more

sim­ple track­ers, which just track one mar­ket. The most pop­u­lar mar­kets were the FTSE 100, FTSE 250 and the S&P 500 in­dex in the US.

How­ever, mar­kets have fallen in re­cent months. In Oc­to­ber the FTSE All-Share had its worst month’s per­for­mance in more than three years, with the past 10 years only see­ing eight months that had greater falls.

What’s more the FTSE 100 was down 5% over Septem­ber and Oc­to­ber, leav­ing it down 7% in the year so far.

UNAPPRECIATED RISKS WITH PAS­SIVE IN­VEST­MENTS

If in­vestors fear fur­ther mar­ket falls – whether due to Brexit, trade wars, the fall in grace of the FAANG tech­nol­ogy stocks or some other rea­son – should they switch to ac­tive fund man­agers?

Jane Sy­den­ham, in­vest­ment di­rec­tor at wealth man­ager Rath­bones, says: ‘One of the key is­sues here is that pas­sive funds are re­ally untested in a se­ri­ous mar­ket fall. We are 10 years into a bull mar­ket, in which pas­sive in­vest­ing has ex­ploded in pop­u­lar­ity, such that it now dom­i­nates daily mar­ket ac­tiv­ity – that was not re­ally true in 2008.’

Track­ers have no abil­ity to out­per­form the mar­ket, and in a de­clin­ing mar­ket that means these in­vestors have no way of lim­it­ing their down­side. An ac­tive fund man­ager will aim to avoid the worst-per­form­ing com­pa­nies and stop in­vestors’ sav­ings falling as much as the mar­ket does in any down­turn.

What’s more, they will also be able to buy the dips, and snap up un­fairly dis­counted shares in a mar­ket fall. This re­lies on you pick­ing the right fund man­ager who makes the right calls in hard mar­kets – no easy feat when many fund man­agers have been in­vest­ing in a bull mar­ket for the past decade.

Sy­den­ham com­ments: ‘In the­ory, it is likely that ac­tive funds will per­form bet­ter as they can hold liq­uid­ity and buy more con­cen­trated po­si­tions of over­sold hold­ings when they have fallen heav­ily.

‘In mar­kets that are no longer dis­torted by quan­ti­ta­tive eas­ing, there should also be more dis­per­sion be­tween stronger and weaker stocks, and that should also favour ac­tive funds, but the man­agers of ac­tive funds have to still make the right de­ci­sions, so in­vestors need to be con­fi­dent in the abil­ity of the ac­tive man­ager.’

WAYS TO PLAY CHEAP UK MAR­KETS

One par­tic­u­lar area of op­por­tu­nity is in do­mes­ti­cal­ly­fo­cused UK stocks, which have been hit since the ref­er­en­dum vote and dur­ing the on­go­ing Brexit uncer­tainty, mean­ing many com­pa­nies are now sit­ting on healthy dis­counts.

Cur­rently FTSE 100 com­pa­nies are trad­ing on 12.5 times earn­ings, which is be­low the his­tor­i­cal av­er­age, with a div­i­dend yield of 4.5% – above the long-term av­er­age.

In­vestors who think there is op­por­tu­nity for UK-fo­cused stocks to re­bound could con­sider in­vest­ment fund Man GLG Un­der­val­ued As­sets (BFH3NC9).

Henry Dixon, who runs this £1.2bn port­fo­lio, aims to hunt out dis­counted com­pa­nies that he thinks will rise in value.

In­vestors look­ing for down­side pro­tec­tion can in­vest in funds that specif­i­cally aim to re­duce volatil­ity and pro­tect in a mar­ket down­turn.

A good ex­am­ple is the £2.5bn Janus Hen­der­son UK Ab­so­lute

Re­turn (B5KKCX1), a fund run by Ben­jamin Wal­lace and Luke New­man. The fund can ‘short’ stocks, so ef­fec­tively bet against them, and aims to de­liver a pos­i­tive re­turn and to drop less than the FTSE All-Share in a falling mar­ket.

Both the Man GLG and Janus Hen­der­son prod­ucts fea­ture on AJ Bell’s list of favourite funds.

“One of the key is­sues here is that pas­sive funds are re­ally untested in a se­ri­ous mar­ket fall

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