When is the right time to use active funds?

When is the right time to use active funds?
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The market conditions that existed in the decade between the end of the global financial crisis and the start of the Covid-19 pandemic were ideal for enabling passive to outperform against active funds.

Record low interest rates and the policy of quantitative easing helped boost the performance of all risk assets, particularly at a time of generally benign economic growth.

The programme of QE made bond prices more expensive, and minimised the returns available from cash deposits, encouraging investors into riskier assets such as equities and property, with lower than usual volatility.

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So, an investment in a broad equity market tracker would have attained substantially positive returns for a decade, denting the appeal of actively managed funds, which would be expected to perform best at times of greater volatility. 

The pandemic brought new waves of QE around the world, and further interest rate cuts, leading to a rapid recovery in asset prices in 2020.

But with the path out of the pandemic uncertain across different regions of the globe, and its impact hitting each sector of the market differently, the conditions in which active management does best may be starting to assert themselves. 

John Husselbee, head of the multi-asset investment team at Liontrust, says investors should never view it as an either/or choice in any market conditions.

The fund manager says that while market conditions will always exist that cause certain active investors to underperform, portfolios designed with the long term in mind should combine both.

He says: “We have long held the view that active versus passive is a needless debate for fund investors, and they should choose both. Of course, investors in active funds should note that they will need to have the patience to withstand potentially lengthy periods of underperformance on the way to long-term wealth generation. This is what we refer to as noise-cancelling investment, which is central to our patient multi-asset approach."

A recent study from Vanguard looked at a data set of more than 2,500 actively managed US-domiciled funds over 25 years to the end of 2019. The research found almost all the outperformers experienced sharp falls versus their benchmarks and peers over several one, three and five-year periods.

Meanwhile, 80 per cent of the outperforming funds also had at least one five-year bottom-quartile spell and top managers can expect a continuous fall in fund values lasting at least two years every decade and a worse fall of at least 20 per cent. A separate study from Morningstar showed that even a very skilled manager, over a span of 100 years, would underperform their benchmark for a two-decade period during that time.”

Tom Sparke, investment manager at GDIM, says: "We use passives in a couple of different ways in portfolios. Where we are looking to gain exposure to a specific asset we may use a tracker fund where an active fund does not provide a higher degree of value. For instance, in the bond space we have not seen much value in allocating to actively managed gilt funds and prefer to pay a low fee for general tracking of the market.