It pays to be active

Over the years, it has helped millions of investors build long-term wealth. In some instances, investors have become Isa millionaires. It is an example of an industry that has put the great in Great Britain.

Great brands – the likes of Invesco Perpetual, Jupiter and Schroders (and many more besides). Great iconic fund managers – none better than Neil Woodford.

Of course, the industry’s success has made scores of its most impressive investment fund managers and executives seriously rich along the way.

Indeed, many of them live in upmarket Kensington in west London whose gold-paved streets I tread every day on my way to work (they occasionally greet me with a royal wave before revving up their Porsche Cayenne and dashing off to work in a plume of exhaust fumes).

Providers of certain investment platforms have also prospered – and well done I say (not an ounce of envy in me).

Yet, no sector, however successful, is ever immune from close scrutiny – or from pressure to change. The retail investment fund industry is no exception.

In recent years, the industry’s reliance on ‘active’ fund management – breathing humans at the wheel rather than computers – has increasingly come under the spotlight. As has the charges it heaps on investors, either disclosed or hidden from view. The cry for more passive investment management becomes louder by the day.

I was made fully aware of this a few days ago when I tweeted an article I had written on Douglas Brodie, a shrewd investment manager at investment house Baillie Gifford.

The Edinburgh-based investment house is perceived as conservative with a small C from the outside, but it is radical in pursuit of investment performance. Its managers are bred to stock pick. Index tracking, closet index tracking, are an anathema.

Mr Brodie manages the Global Discovery Fund, and he does it with aplomb. Through astute stock picking, he has delivered three-year returns double those of the average global investment fund and way in excess of the FTSE All Share Index (the benchmark all investment funds should be measured against).

Yet my review of Mr Brodie’s intelligent investment approach – hunting down the business stories of the next decade – did not go down well with some financial experts. All kinds of brickbats were hurled my way.

“All flipping coins”, said one expert, describing what he thought active funds managers bring to the investment party. “Some of them will have six heads in a row.” In other words, active fund management is all about luck rather than shrewd investment judgement.

Another was more acerbic. “Why, Jeff, why?” he asked. “Helping to perpetuate the myth that lead can be turned into gold. Shame on you.” Translated, this read: “active management bad, passive management good”.

In a separate message, he asked: “But did the Mail [the newspaper I work for] tip [I don’t tip] him [Brodie] before he outperformed? Doubtless, readers will pile in now, just in time for mean reversion.”

In a blog posted by this same individual, he said that financial advisers should stop recommending active funds and instead consider a completely new approach – “a proposition built not on any claim to be able to forecast the future, or identify the best funds. But one that is founded on giving their clients the very best chance of achieving their financial goals, and keeping them on track when their human emotions put those goals in jeopardy.”

In a nutshell, index-tracking funds rule and active funds are passé.

I do not have a problem with the growth in index-tracking funds and exchange traded funds (mighty big in the US). But to dismiss all active funds in such a cursory fashion, as my brickback hurlers do, is wrong.

To dismiss all active funds in a cursory fashion is wrong.

According to performance data from Trustnet, the average UK all companies investment fund has outperformed the FTSE All Share Index over the past one, three and five years.

Over the past five years, the average UK all companies fund has delivered a return of 37.7 per cent. Over the same period, the FTSE All Share Index has delivered a return of 32.1 per cent.

Of the 234 funds in this sector with five-year records, 140 have outperformed the FTSE All Share. Of the 94 that have underperformed, there are a raft of index-tracking funds among them, run by the likes of Fidelity, Henderson, Legal & General, M&G Investments and Scottish Widows. Of course, index-tracking funds will always underperform as a result of the charges they levy.

These figures indicate that there are plenty of active fund managers that continue to outperform the market – principally capturing return by identifying undervalued stocks that come good at some stage (exactly what Mr Brodie does for a living).

This is something an index fund can never do because its modus operandi is all about investing in an index that is overweight in overvalued stocks and underweight in undervalued stocks.

So, it is my contention that active fund management still has a key role to play in delivering investment return to investors.

Of course, there are areas where improvements need to be made. Closet index-tracking funds should be exposed and forced to reveal their true selves (something the Financial Conduct Authority is on to).

Fund charges also need to be more transparent. For example, it would be good to see other investment houses follow Woodford Investment Management’s lead in bearing the cost of broker research rather than passing it on in an underhand way to fund investors.

But just because some active fund managers – principally the banks – do a particularly bad job at investment management, it is no excuse to throw the baby out with the bath water. There are plenty of active fund managers out there, like Mr Brodie, who still rock.

Jeff Prestridge is personal finance editor of the Mail on Sunday