Seismic shifts in investing

This article is part of
Passive Investing - October 2014

Active investing has been a staple in the UK for many years, with investors prepared to put their faith and money behind ‘star’ fund managers who they think are able to offer better returns, but times are changing and we are increasingly following the ‘passive’ lead from the US.

The move towards fee-based advice that we currently have since the onset of RDR in the UK, occurred organically around a decade ago across the pond, which is one of the key differences between the two markets. But an increasing appreciation of the futility of following an active strategy is also changing attitudes here.

Despite a level of confidence in the fund managers who charge a premium for their services, a recent study by the Pensions Institute at Cass Business School found that just one in 100 active fund managers actually managed to beat the index returns between 1998 and 2008 after fees.

Professor David Blake who wrote the report, stated: “Taken together, the results prove that the vast majority of fund managers in our dataset were not simply unlucky, they were genuinely unskilled.

“However, a small group of ‘star’ fund managers are genuinely skilled and hence able to generate superior performance, in excess of operating and trading costs, but they extract the whole of this superior performance for themselves through their fees, leaving nothing for investors. While ‘star’ fund managers do exist, all the empirical evidence indicates that they are incredibly hard to identify.

“For most investors, our results show that it is simply not worth paying the vast majority of fund managers to actively manage their assets.”

When presented with evidence like this, it is no wonder the passive investment market in the UK is starting to grow, and it is being driven by the younger generation. More than one in six people aged 30 has a passive fund in their portfolio according to research from Bristol-based Hargreaves Lansdown, compared to the national average of one in nine, with five times more of their portfolio in tracker funds than those in their 70s. It has seen its tracker fund holdings grow by 50 per cent in the last 12 months, according to Adam Laird, passive investment manager for Hargreaves Lansdown.

He added: “Tracker funds are low cost, straightforward investments. Their simplicity appeals to younger investors who may be starting to build an investment portfolio. Costs have been falling and investors can now access all major bond and equity sectors for under 0.25 per cent ongoing charge.”

Charges are not the only consideration when choosing a tracker fund, said Mr Laird, but the relatively low-cost of trackers has undoubtedly boosted their appeal in recent years even though the concept of index tracking has actually been around since the 1970s. But its growth has been more evident in the last decade, and the Investment Management Association data shows that around 14 per cent of all equity assets are now in index funds, according to Ayesha Akbar, portfolio manager at Fidelity Solutions.

She added: “Increased choice is not the only factor behind the growing popularity of index funds. Management charges have been trending downwards and regulatory changes may be having an impact too - the move to fee-based charging and clean share classes has eliminated any issues relating to how advice is paid for. There may also be a growing acceptance that active and passive strategies both have their merits and can be combined together within client portfolios. All these factors could explain why, according to industry statistics, advisers are increasingly utilising index funds within model and bespoke portfolios.