Trying to mix passive and active funds
Striking a balance between active and passive is a consideration when trying to deliver returns.
It has long been argued that allocating to the right types of asset is key to making attractive returns – particularly for funds in the IMA’s mixed asset or former managed sectors. However, data from FE Analytics suggests that the question of whether to invest in passively or actively managed funds can also play a big part.
In 2008, the year that the global recession hit, passive funds that tracked indices outperformed active ones that attempted to beat them. The iShares MSCI World exchange-traded fund, which tracks the MSCI World global equity index, lost 16.7 per cent in 2008. This compares favourably with a 24.3 per cent loss for the average fund in the IMA Global sector – the vast majority of which are actively managed global equity portfolios. However, when markets rallied in 2009, the IMA Global sector was quicker to recover, returning 22.95 per cent, compared with the iShares tracker, which returned 15.9 per cent.
These kinds of trends are observable over shorter and longer periods as well. The iShares tracker returned 8.35 per cent in the first quarter of this year. Had investors instead chosen to put their money with an active manager during this period, they would have more likely than not underperformed, as funds in the IMA Global sector on average only returned 5.37 per cent. Although passive funds will have by definition underperformed the index, the scale of the underperformance for a cheap passive fund will on average have been lower.
Over the five years to June, the average fund in the IMA Europe excluding UK sector outperformed the MSCI Europe excluding UK index
In active funds’ favour, however, over the five years to June 15, the average fund in the IMA Europe excluding UK sector outperformed the MSCI Europe excluding UK index, according to research house Morningstar, partly because many funds have been avoiding crisis-hit areas of the eurozone that form part of the stockmarket index.
Analysts, IFAs and asset managers alike agree that active and passive funds can work in combination. However, getting the right mix at the right time could be the difference between outperforming and undershooting the benchmark.
Exploiting the divide
Predicting how active and passive will perform is difficult, however. In first set of examples above, actively managed funds underperformed during the falling markets of 2008, when investors took less risk, and outperformed during the rising markets of 2009, when investors took more. But according to Ben Seager-Scott, senior analyst at Bestinvest, if investors pile into riskier assets, the opposite effect can pertain. “Hot money flows in, most of which tends to go into indices. This is when passive instruments can outperform because active manager will often have different positions from the benchmark,” he says.
The second set of examples illustrate how the effect can work in reverse. In the first quarter of 2012, the iShares passive fund outperformed in a rising market, while over the five years to June 15 active Europe excluding UK funds outperformed in spite of overall falls in European indices.