Since the inception of the first passive ETF investment strategies way back in 1975 the argument as to which is ‘better’, active or passive, has raged on.
Whilst it’s difficult to argue against their popularity, should passives be the default option or are above-average returns possible by investing with an active manager?
Looking at the UK, and specifically at the monthly returns over the last 20 years for all funds in the IA UK All Companies sector (255 funds currently), there have been 139 months when the index has produced a positive return and 101 months when the return has been negative. In those negative months, the average active manager performed better than the index in 64 of them or 63% of the time*.
Whilst interesting and encouraging for active managers in its’ own right, it is important to note that this only considers the average manager. Of course, by definition the ‘average’ active manager will perform in line with the index, but there is some evidence that the best among them fare better in more difficult environments than their passive peers.
Within the Close Managed Funds range, ‘average’ is not the pond we are fishing in – we are always trying to find the very best global fund managers in every sector.
Let’s take a step back and think about what an active manager is trying to do. Simple passive strategies typically ‘own’ the whole market, whether poor, average or good companies; active managers try to isolate the leaders of the pack. They don’t want mediocre.
They want to find an edge by ‘out-analysing’ the market and so will focus on elements like balance sheet strength, the ability to survive tougher times, to disrupt competitors or even overthrow the very industries which spawned them. Essentially, they are looking for investments that will do well in the future.
This is at odds with the index, which by definition is an index of yesterday’s winners. So while few managers could have predicted the current crisis, many are likely to have held up better and are able to react more rapidly as events unfold.
Want alternatives? Be active
There are, of course, areas where the ability of an active manager to outperform a passive fund are greater than others – especially where independent research can add value, perhaps in small-cap companies or high yield bonds. In our opinion, one area that should only really be managed actively is ‘alternatives’.
But before we dig a little deeper to explain, let’s ask ourselves why might we want to consider alternatives in the first place?
Across the industry the term ‘alternatives’ is used rather broadly. Perhaps the easiest definition is that they are a ‘catch-all bucket’, essentially anything that doesn’t fall in to the traditional investment categories of shares, bonds or cash. We broadly split them into:
- Real assets (like property or infrastructure)
- Commodities (like gold or oil)
- Absolute return funds
One reason you might include these in any multi-asset portfolio is that they have different drivers of return and therefore should behave differently to shares or bonds.