Passive now needs same knowledge level as active

Gill Cardy

When I started out as an IFA, which seems a terribly long time ago now, investments were so exciting. I had come from Guardian Royal Exchange which, like most life companies, had set up investment management arms to receive the funds from unit-linked pension and insurance contracts, presumably as a more interesting (profitable?) alternative to the with profit fund.

Performance was usually execrable. I never really understood why ‘proper’ investment houses, such as Fidelity and Perpetual, had the monopoly on good performance and why the life companies were, generally, pretty poor. They were presumably recruiting from the same talent pool so why did all the good ones end up with the investment houses?

Anyway, becoming an IFA opened up exciting new possibilities. But there was never any nonsense about explaining the philosophy behind active fund management.

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Everyone paid fund managers to research companies, buy good ones, ignore rubbish ones, and we tried to work out who would do better than others at the job. We discussed whether top-down or bottom-up strategies would be successful. We discussed whether a smaller companies bias, or focus on high-dividend firms, would generate the better returns, but everything was active.

Then all of a sudden we got assaulted with the world of passive investing. But even if you bought into the philosophy, they were considerably harder to access than they are now. Supermarkets did not host them as there were no fees to share, and there was really only Transact reliably in the space if you knew about exchange-traded funds.

Then we discovered passive funds that ‘did other interesting stuff’; index funds with ‘tilts’. Ever the cynic, I argued that if it had a tilt then it was not passive any more. Now in our honourable tradition of ‘complification’ we call this ‘smart beta’.

I am not dismissing the value of passive investing with screens to either focus on the best bits of the index, or avoid the worst companies in the index. I can certainly see value in an approach that takes the benefits of low-cost investment management and attempts to derive some of the benefits of active managers through a computer-driven process (or algorithm if you want to sound clever).

But this seems to bring us back full circle to the need to understand just as much about passive and smart beta funds as we ever needed to about active funds. Thinking these offer shortcuts for advisers would be a big mistake.

Gill Cardy is network development director of ValidPath