Why active management won’t protect you from downside risk


It is dangerous to make assumptions about active fund management. Myths are extremely commonplace, particularly when it comes to downside protection. Steep cliffs apply to active fund management too, spectacularly so in some cases.

OK, so fund pickers may get lucky and guess when the next market correction will hit. But they have to position their portfolio’s accordingly, at the right time, and then get lucky again by holding the specific funds that actually do offer downside protection.

It is a realistic possibility that only a small handful of active funds will actually outperform market-cap weighted indices, and therefore it becomes practically impossible to get the process right.

During the bear market period 9 October 2007 to 9 March 2009, active funds or trusts did no better than passive funds.

In fact investment trusts underperformed their unit trust peers.

Market corrections happen, and happen regularly. It is best accept that there is no magic formula.

We believe it is better to hold a globally diversified portfolio of stocks and bonds. If you have to tinker, tinker around the edges so as not to compound the pain, and risk falling off that cliff.

Rob Wood is a financial adviser at Wychwood Financial Services



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There are 16 comments at the moment, we would love to hear your opinion too.

  1. Just a single point of entertainment… active fund managers have some cash – whether that is 0.5% or 10% but passives by nature must have none. Cash doesn’t fall. However, there is no magic formula but how much is it worth paying for a manager who CAN take some difficult decisions? We have found that some of the best decisions, with hindsight, are to buy near and at the bottom, rather than ‘fortuitously’ avoiding an implosion in the first place.

  2. How selective can you get! Totally worthless. Comparing two specific trackers with generic actives is meaningless. Also how long did it take you to trawl through to find a suitable dates? Active investors choose individual funds (as you have done). Sure some don’t do too well. But others can often be streets ahead.

    I too can be selective:

    From 15-Oct-07 to 16-Mar-09

    RIT Capital Partners ( A Global IT) Lost 25.7%. Witan (another global IT) Lost 34.54%.

    For the UK Invesco Inc & Growth (UK All Cos OEIC) lost 42.35% and their Select Trust (UK All Cos IT) Lost 34.97%

    In my view that makes your figures look a little silly.

  3. Harry, I have not been selective at all. I have picked the actual date’s of the bear market period (highest and lowest points).

    Why is it meaningless to compare actual trackers with average performance after costs? What do you suggest I compare them with?

    • If you are comparing actual trackers they should be compared to actual funds. If you what to compare like with like then it is the relevant indices that should be compared to the sectors. I also agree with Nick Wardle. For every sector with active funds I usually plonk a passive in amongst them to keep the funds honest. If they fall too far behind then they go, but one has to avoid the closet trackers. What counts is the bottom line. I benchmark against the indices the two most important for me are the WMA Balanced Portfolio and The FTSE All World. Those are the two that have to be beaten. If some sectors fall behind at a given time I don’t lose sleep as they are likely to come back when conditions change – just as long as the two most important indices are not in front of overall portfolio performance. Spread is the great mitigator and I invariably use more than 30 funds for portfolios over £150k and sometimes even more for larger portfolios.

      • Ok Harry.

        Aviva International Index -36.29%

        Bankers -34.90%
        JP Morgan Global Growth & Income -37.28%
        Foreign & Colonial –39.42%
        Witan -40.14%
        Monks -43.22%
        F&C Global Smaller Cos -47.45
        Finsbury Growth & Income -47.84%
        Scottish Mortgage -55.62%

        I guess I am back to being selective again.

        • Except you have made a poor selection. The task of an Active adviser is to choose the good funds, not the poor ones and then of course less than two years is hardly a criteria for anything – passive or active. Investing is (or should be) a long term discipline. Ten years or 5 at shortest is in my view far more relevant. No doubt you will now dig out figures to show how wonderful trackers have been in that period.

          But if we take the period January 02 2007 to January 3rd 2017 the FTSE All World produced an overall return of 16.19% and the FTSE All Share 19.16%. (Making the assdumption that equivalent trackers cannot – by definition – outperform the index.

          So compare this to (for example) Witan – who in your illustration over that short term shows up poorly – produced 97.7% over the 10 years. RIT 88.18%. Both Global Funds.

          Now for the UK. Finsbury Growth & Income 101.69% and Invesco Perpetual Select 75.76%.

          These are fairly random examples. You stick with your trackers and your Fiat 500 and I’ll stick with active management and my Audi R8.

  4. Why is the argument always active v passive? Surely the best solution is to mix the approach, passive work better in certain markets how ever actives can often out perform in others.

    The key is to know what your fund manager is trying to achieve (all fund managers will be wrong at some point) and to make sure you aren’t paying active prices for closet trackers.

    After that, diversity and time are your best friends.

    That is our opinion anyway.

  5. Have you ever tried to talk to, or get information out of Aviva, 17 days turnaround.
    There is more to investing than passive or active argument. Service is also key and the difference I have just experienced between Parmenion being asked to turn around a late Client call for a SIPP withdrawal in this tax year, which they managed to do between 22/3 and 5/4 and AVIVA being asked a similat question who even now, have not been able to confirm that the paperwork is in their Scanning dept from a post date of 27/3/17!!

  6. Over these dates average UK all company fund slightly underperformed FTSE all share (-41% v -39%)

  7. Chris Taylor, The Investment Bridge / Alpha Structured Products 10th April 2017 at 8:15 am

    Neither active fund management OR passive does a good job of protecting investors from downside market risk.

    Active just isn’t very good at it, even when it tries – in fact it’s not that good at giving investors the upside of the market either (reference S&P analysis a week ago, showing that 87% of active UK equity funds failed to even match the benchmark in the past year, post Brexit Trump, etc: a period that should have proved the worth of active).

    And passive doesn’t try – that’s not what it’s there for.

    Neither is diversification, in the rudimentary sense of it (i.e. diverisify asset class and geography, etc.), a watertight strategy for controlling downside risk. In times of major macro stress/distress, such as the global financial crisis, correlation increased, with pretty much everything going down.

    And we now also have plenty of long term history to highlight that time (even a 5 year+ time horizon) is not always the great healer for investors.

    BUT, consideration of this issue shouldn’t be limited to just active / passive. The structured products sector is now coming of age, as a credible sector that can provide strategies and propositions that neither active nor passive are capable of, that can truly protect investors from downside market risk – either removing it completely (in the case of fully protected investments and structured deposits) or at least reducing it (in the case of structures with deep downside barriers, which can also be set up so that they are only assessed at the maturity date and cannot be breached during the investment term) or defining it (i.e structures can contractually ensure that downside if the same as the index, but with no risk of worse downside as is the case with active funds).

    Importantly, structured products can also improve the upside ‘risk’, which is often not thought of as a risk – this being the risk that markets do not rise but are instead range bound/sideways moving and that positive returns are not generated for investors. Most structured products seen in the UK professional adviser channel are designed to generate positive returns without requiring the market to rise, and some are even designed to deliver positive returns if it falls.

    All in all, structured products can increase the likelihood of positive returns being generated for investors, and decrease the likelihood of capital losses being experienced. Hard to argue with/dismiss that as an investment principle? Yes, they exchange market risk for credit risk, i.e. the counterparty must stay solvent – but that is now well understood and dealt with very transparently by the sector.

    As part of a diversified portfolio – that diversified investment ‘type’ as well as just asset class and geography – there is now plenty of empirical evidence highlighting the efficacy of structured products and their ability to add value alongside/complement active and passive fund management.

  8. I may be confessing ignorance by writing this but I’d not been aware of anyone ever having claimed that any active fund or portfolio, by comparison with its passive counterpart, offers better protection against downside risk. Isn’t the primary (claimed) virtue of (carefully selected and regularly monitored) active funds or portfolios that, over the medium to long term, they can/should deliver better returns than their passive counterparts and that these better returns outweigh the slightly higher costs? There can, of course, be no guarantees that this will be the outcome but those are the objective and realistic possibility.

    • Chris Taylor, The Investment Bridge / Alpha Structured Products 13th April 2017 at 11:28 am

      Active fund management’s raison d’etre is essentially alpha delivery, Julian – ie outperformance versus the benchmark, whatever the benchmark has done, ie risen or fallen. So, if markets fall, active fund mgmt should fall less, ie protect on the downside. This article highlights that it might not be very good at that. If it’s also the case that it doesn’t do a great job of delivering upside outperformance then both the raison d’etre and the fees charged for existing are hard to justify, vis-à-vis accepting the market’s returns and only paying for beta. This is what is now under increasing scrutiny, with the FCA assetmgmt paper, and ‘third way’ smart beta, structured options, etc., also adding to the considerations …

  9. Am I to take it that the moderator on this site doesn’t want trackers to appear in a poor light? I ask because my repost to Rob Wood 7th April 4.04 was not posted. I make a second attempt:

    Investing should be a long term undertaking. We have been looking at an 18 month period. Really pretty meaningless. A ten year view is eminently more sensible in my view. In which case we have the following statistics:

    From 2nd January 2007 to 3 January 2017 The FTSE All World produced 16.2% (241.04 to 280.08) and the FTSE All Share 19.16%. (3265.89 to 3891.54). When we consider that a tracker cannot by definition outperform an index I guess the indices I have chosen will suffice.

    Over the same period RIT Capital Partners grew by 88.1% (989.5p to 1862.0p) And Witan (who you tried to show up poorly) by 97.7% (458.0p to 905.5p) (Both Global IT and compared to the All World Index)

    Finsbury Growth and Income grew by 95.5% (324.0p to 633.5p) – So much for your 17 months figure! Invesco Perpetual Select by 74% (100.5p to 174.88p) Both UK All companies.
    Sure there were lemons, but you can also choose a poor index fund. Brazil for example?

    But you stick to your trackers and your Fiat 500 and I’ll mainly invest active and an Audi R8

  10. I don’t know where you are getting your figures from Harry but the FTSE All World Index went up by 143% (including divi’s) in the period you mention and the FTSE All Share 70% (including divi’s) according to FE Analytics. No wonder your figures look good.

    We all know active funds generally underperform lower cost options over the long term (the exception being the minority without the benefit of hindsight ), but the whole point of the piece was to show how well funds/sectors do in period of market stress. This is what you personally said the other day in response to Chris Gilchrist’s piece the other day:

    “It must also be recognised that investing is not only about how much you can make when markets are doing well, but how little you can lose when they are doing badly – and this is where passives fail spectacularly. Diving off the top board without trunks. Active management can (and should) be at least some defense in falling markets.

  11. My figures are from Sharescope and at least I have had the courtesy of disclosing the actual figures as well as the percentages. Indeed the FT figures also bear out Sharescope. I don’t know where or how the FE Analytics gets their figures, but they are at variance from these other sources.

    You now resort to including dividends to enhance your case where all my figures are purely on the share price. Methinks you are desperately flogging a very dead horse.

  12. Talking about dead horses, sounds like a stock return without dividends!

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