Woodford is not the death knell for active management

Nic Spicer

Nic Spicer

A media firestorm has ensued following the Neil Woodford debacle.

Last week we joined the fray, blogging on the importance of liquidity. And there are many other valuable learning points emerging.

But there is one particular narrative strand being woven that we certainly do not agree with: that Mr Woodford is symptomatic of the failure of the active management industry.

Some articles even suggest that this could be the final nail in the coffin of non-index trackers, an argument bolstered by various studies that active managers, on average, underperform their index.

While PortfolioMetrix certainly is not against passive management, and indeed uses it in certain cases, we take issue with this blanket view and remain a big believer in active management overall.

But how can we maintain this confidence in the face of Mr Woodford’s current difficulties and the arguments being made?

And just what does ‘believing’ in active management mean anyway?

In short it comes down to a delicate blend of pragmatism and opportunity.

We do have to be realistic and admit that active funds will go wrong from time to time.

You may have avoided Mr Woodford (as we did) but it is impossible not to get it wrong occasionally.

With active, there is no success without failure. Likewise, it would be imprudent not to acknowledge the point that the average active manager is likely to underperform their index; indices do not post performance net of fees, while active managers do.

However, there is also opportunity when you note that a population of active managers should not be defined by its worst, or indeed its average, member.

To believe in active management is to believe that although luck does play a part in investment outperformance, it is not the only determinant - skill can and does exist.

It is also to believe that it’s possible, through hard work, experience and keen insight, to identify these skilful managers in advance. This is the value that can be added through good manager and fund selection.

All of this may be true at an individual level, but some advocates of passive will then switch to a more high-level argument: even if some individual managers and fund selectors can indeed outperform, how can an industry that, on average, underperforms be allowed to continue to exist?

Surely the regulator could protect investors from future situations by requiring them to invest in ‘safe’ index trackers?

This is an argument that falls down quite quickly once the implications are fully worked through.

It may sound trite at first, but not everyone can switch to passive management.

Markets do, and will always, require active decision-making to function.