I’m always wary of igniting the debate between active and passive investing as it draws so many polarised views; however, I think the recent regulatory changes could draw a new perspective.
I’m not going to argue for one or the other, especially as an investor I hold both. So instead, I will point towards an interesting outcome of the emerging pricing models that have been developed to meet the requirements of the RDR.
The comparisons between active and passive investing have always been made based on extremes. An active fund is typically positioned at costing 1.5 per cent a year, with a passive fund approximately at the 0.25 per cent mark.
This provides a stark comparison, especially when it is presented alongside the proportion of active funds that fail to outperform their benchmark.
This argument has always been misleading, since active funds have typically carried the cost of distribution, covering both the commission payable to an intermediary as well as platform fees. Although some passive funds have done this in the past, the majority are now priced at their net cost, and represent just the cost of accessing the cost of the investment.
This is due to change. The result of the FSA banning commission this year has led to fund managers launching new share classes that exclude this cost. This has led to a more representative comparison between active and passive products.
An active equity fund is now emerging at roughly 0.75 per cent per year and as such the gap between active and passive doesn’t look so big anymore.
So what is the impact of this? I decided to analyse the range of active and passive funds available through FundsNetwork and reviewed their three-year performance. On the old basis of pricing active funds you could see that just 45 per cent outperformed their benchmark. However, if instead active funds are reviewed under their new pricing model, removing commission and the platform fee, it rises to 60 per cent – a much more acceptable level.
Clearly when you compare this to a passive fund, which will almost always under perform its benchmark, this is a more interesting comparison. It also needs to take into account the platform and adviser charges need to be paid, but this is true whether you go active or passive.
Passive funds have always tended to underperform their benchmark due to the cost of the management fee, albeit stock lending can sometimes alter this position. When the platform and adviser charge is added on top, it leads to a sizeable performance drag. The only way to make passive-only strategies combat the drag of charges is to combine it with an active asset allocation model.
Overall, I think there is a role for both active and passive investing. Generally an efficiently run portfolio usually contains both. However, I am hoping now that the decision to use one or the other is driven by investment criteria and not by cost alone. The new regulatory regime should now place active and passive investing on an even footing. While I’m sure we won’t hear the end of the active versus passive debate for years to come, at least in the UK, we’ll be comparing apples with apples.
Ed Dymott is head of business development at Fidelity Worldwide Investment
