Investments  

What’s behind the growing appeal of passive funds?

    CPD
    Approx.30min

    The passive-versus active debate is raging hot as ever these days following the release of research suggesting that when weighted for size, active funds actually do outperform their passive counterparts.

    Several people in the industry have spoken to FTAdviser, outlining their arguments why passive funds may be slowly increasing their market share.

    Control

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    According to Alan Dick, partner at Forty Two Wealth management, the main appeal of passive funds is increased control, paired with the bonus of keeping costs down.

    Although he aims to maintain independent status after the Retail Distribution Review, he claims Forty Two can continue offering only passive products.

    Mr Dick said: “We believe in controlling anything we can control. We can’t control fund managers and their whims and any bets that they may take. If we can remove that risk and the cost that goes with it it’s a double win.”

    Both control and cost are affected by the frequency of the fund manager trading.

    Mr Dick continued: “By using passive funds you also cut down on the cost of trading within the fund itself.

    “A fund manager who actively tries to beat the market will be buying and selling assets all the time and this means stamp duty, stock broker fees and more.

    “An average active fund turns over 70 to 100 per cent of the portfolio in a year. A typical passive portfolio turns over around 5 per cent per year so the tide you are fighting against is much weaker.

    “There is data out there that tries to analyse what that number is but it’s very difficult to put a number on it, but there is a drag on the fund because of these charges.”

    According to Mr Dick, costs for a fund manager in a portfolio Forty Two would use would typically run to about 40 or 45 basis points in terms of total expense ratio.

    He added: “Our fee is 1 per cent of the investment initially and 1 per cent per annum ongoing. We would be taking the same 1 per cent whether we were using passive or active. It’s cheaper for the client because the investment is cheaper.”

    Selling peace of mind

    Alistair Cunningham, director and chartered financial planner at Wingate Financial Planning, says the RDR signals a shift from selling products to selling a plan, and this in turn will herald a further shift towards passive funds.

    He said: “We have very, very slightly more money in active than passive, but in the past year we have put more money in passive. We are genuinely agnostic but if you look at the financial planning versus financial advice debate many adviser firms will sell products and investments which will probably lead to an active strategy.

    “However if you are a financial planner then your product is a financial plan and peace of mind. While you can’t ignore active, performance becomes less of a priority.