The age-old active versus passive debate is still rife. If anything, it has become even more prominent as investors look for safer ways to invest and achieve income, particularly post-retirement. With the overhaul of the retirement market announced in the Budget the use of a fund could be ever more important.
Passive funds are often treated as the less exciting version of active funds, and more focus is given to active. But is this justified? The ‘active’ side says passive funds do not outperform the market and it has even been claimed that monkeys could do better. But the ‘passive’ side says passive funds are cheaper and safer over the long term.
Since the implementation of the RDR, pressure to justify costs has seen advisers find cheaper options for clients, driving demand for passives.
So how are the costs kept so low? Dan Attwood, proposition manager of retail index funds at Legal & General Investment Management, says the reason passives are much cheaper than active funds is simply down to the management.
“One of the things is that index funds won’t do as much individual stock research, not as many analysts being employed to manage the funds and it is very scalable,” he says. Additionally, with an increase in assets under management the investor does not have that much more in terms of costs. “Once you achieve scale you can keep costs low. In terms of managing index funds, one of the most important things is to have scale. Without scale, it’s not going to work and you won’t be able to generate efficiency.”
“In terms of index funds, it is not just the savings in fees, it is the savings in transaction costs. For example, an index fund is much more likely to have less portfolio turnover than an active fund. And in terms of portfolio turnover, it increases transaction costs - which is not part of the ongoing charges - but it comes out of performance,” he adds.
Fair comparison
It is true that passive funds are generally cheaper than their active counterparts but is this enough? To find out, one must compare active and passive funds’ performance to see if the difference is really as strong as each side claim.
