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Why active funds are down but not out at half time

Why active funds are down but not out at half time

Having recently enjoyed a feast of inspiring World Cup performances, I was prompted to check out how competitive active funds have been for the first half of 2018. 

I’m on the record as saying 2018 could be a good year for active funds.

Typically, late-cycle environments precede a rotation out of momentum-biased exchange-traded funds (ETFs) and the increasingly expensive large-cap stocks they invest in, providing fertile ground for active stock pickers.

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There is no doubt that flows into passive funds in Europe and the UK have been buoyant over the past few years.

Thomson Reuters Lipper data reveal that the average annual percentage of passive pan-European fund flows (ETFs and tracker funds) of total fund flows was a modest 5 per cent from 2004-2014.

There was some evidence of reaching “peak passive” at the end of 2017.

In 2015, passive vehicles had a huge year, constituting 32 per cent of total fund inflows. For 2016 this figure fell to 24 per cent, and for 2017 the figure was 18 per cent.

However, in the first half of 2018 the provisional figure has risen again to 39 per cent, suggesting the love affair with passive funds is far from over in Europe. 

Performance-wise, in the first six months of this year passive vehicles are still leading by a goal or two.

Around 40 per cent of active funds in the Lipper UK Equity classification beat the highest ranked broad-based tracker over the period.

In the Lipper Europe ex UK classification the figure was higher, with 43 per cent of active funds beating the highest ranked broad-based tracker fund. For the Lipper US Equity classification the figure was 31 per cent.

When it comes to performance comparisons, it is important to consider the “opportunity cost” of not investing in an active fund (i.e., the potential outperformance of an index).

Often, this can be considerable.

For example, for the five years to the end of 2017 the best performing active fund in the IA UK All Companies classification outperformed the highest ranking broad-based tracker by around 85 points —not inconsiderable.

For the first half of 2018 the comparable spread over the period was over seven points. There are certainly some active players on the pitch performing strongly.

Of course, one needs to have correctly identified these winning funds in advance of the performance outcomes.

While I still believe that, over the longer term, persistency of alpha generation can be found (consider, nearly 75 per cent of the Lipper Fund Award trophy winners of 2014 were in the first or second quartile of their sectors for three-year performance at the end of 2017), over the first half of 2018 random selection would have favoured a passive option.

On the face of it the first six months of this year have been fairly nondescript for active funds in aggregate.