Choosing active or passive 

This article is part of
Guide to picking a fund

Choosing active or passive 

A feature of advice industry over the past decade has been the growth of assets into passive investment products, which simply track a market and deliver that level of return for clients.

As FTAdviser has previously reported, investors withdrew an average of £3.5bn a month from active funds since the introduction of the Mifid II rules in 2018.

Those rules increased the clarity around the true level of fees and charges paid by clients in a fund.

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Equity bull market

But Gary Potter, who uses both active and passive mandates in the range of multi-manager funds he oversees at BMO Asset Management, believes the rise in demand for passive investment products coincided with the strong equity bull market which occurred in the years immediately after the, global financial crisis, 

Mr Potter said it is “logical” that if an investor thinks a market is going to rise by 10 per cent “they would buy a passive fund and just get that market exposure.

"But active fund managers prove their worth when conditions are more volatile, and that is why I think we will see a change now.” 

Net sales and funds under management at February 2020
 Funds under management Net retail sales
All funds£1,256.3bn£1,352m

Source: Investment Association

For Mr Seager-Scott, the decision on whether to use an active or passive fund comes down to how strongly he believes in the ability of the available active fund manager to beat the index. 

He says: “There is also a consideration for whether the market you’re looking at is one where there is a lot of scope for active managers broadly to add value, or whether it is a more simple or efficient market where there is less scope to add value.

"Since most active fund managers generally underperform an index, I think you should really have evidence-based conviction in your manager before using an active fund, and also be mindful of costs, as these are one of the few elements of performance that can be known with confidence in advance.” 

Mr Willis adopts the same view.

He says: “If the view is that a passive fund does provides us with the exposure we need then we conduct a  simple screen on what funds are available, what are they tracking, how well they do it and how much they cost. 

"Sometimes it makes sense to focus on the value you get and not just the price you pay.

"So if we have conviction on an asset class or equity market we may want to gain exposure through actively managed funds if we have confidence that they can add value.

"There are some areas where you cannot get a passive equivalent, such as UK smaller companies and absolute return funds. As such, an actively managed fund is the only option here.”

Tom Sparke, Investment director at GDIM, says his starting point is to ask if a passive fund could do the job, and if not, then he looks at active products.