View more on these topics

Active v passive debate not helped by flawed research

I was interested to read the articles which claimed, based on research by Hargreaves Lansdown, that actively managed funds beat passively managed ones. This was apparently based on measuring compounded returns over several cumulative periods of years ending at the present.

The problem with this approach seems obvious but perhaps it will bear illustrating by a simple example. Fund A has returns of 0.5 per cent every single month for five years, after which it will have returned just under 35 per cent. Fund B has returns of zero in 59 consecutive months but in the 60th month it rises by 100 per cent. Fund B will therefore be ahead of Fund A over one, two, three, four and five years even though it actually only outperformed Fund A in one month out of 60.

The article makes the rather dubious claim that this constitutes consistency. I suggest that it constitutes nothing of the sort, as the same (recent) periods are clearly counted in all the longer-term cumulative figures.

Having applied a shaky methodology, it is perhaps unsurprising that the conclusion that “true active management is worth paying for” is going to be slightly shaky, too. Just because some actively-managed funds outperformed passives over a period, how does that help us when deciding which, if any, will do so in the next period? Surely the conclusion is not that all active funds outperformed passives?

The problem is that, even to the extent that there are market inefficiencies that can be exploited by active managers, it is impossible to do so consistently (as in period after period) and the costs of it all wipe out the outperformance, anyway.

Such was the conclusion of an article in the Journal of Portfolio Management in 2000 and several others before and since.

It should be evident that the costs referred to are those of the funds themselves and so do not take account of whatever costs the person recommending the fund to the investor is incurring (and presumably passing on) in their efforts to pick the winners and avoid the losers. If an adviser makes a point of claiming to be able to pick winners consistently, there is something of a vested interest in being able to prove that there is value added by the approach.

Unfortunately, there is much evidence to suggest that the extent to which such winners can be picked consistently is largely explicable by random chance and not skill.

There is, however, far more value to be added by applying the principles of financial planning, whereby the portfolio&#39s asset class exposure is linked to the investor&#39s goals. Perhaps this is where advisers should be focusing more of their attention, particularly in an environment of probable lower future returns.

If the market returns 6 per cent a year, is it better to pay 0.4 per cent to capture the market return or 1.5 per cent in the unproven hope of capturing more?

There is a further problem with using this sort of raw data – the only funds which have a performance record today are those which have survived. A number of funds which real investors purchased in the last 10 years have simply disappeared. Since managers generally tend to keep their better performers and close or merge the others rather than vice versa, this introduces a further confusion into the data and has the effect of overstating the performance of those funds which do survive.

Perhaps this issue was dealt with in the study but there was no mention of it in the article so it is perhaps reasonable to assume that it was not. If the data is skewed, we should not be surprised if the results are skewed also and this once again will tend to make active funds appear in a more favourable light than they deserve on an objective basis.

I am all in favour of debate on the active/passive issue and I do have a high regard for some of the staff at Hargreaves Lansdown. However, this sort of woolly thinking does not contribute much to the debate and might lead more people to conclude that perhaps Ron Sandler might have a point about the inadequate investment skills of IFAs.

Robert Lockie

Certified financial planner,

Bloomsbury Financial Planning, London EC2


Mastek appoints Le Beau to board

India-based IT services specialist Mastek UK is appointing Le Beau Visage founder Peter Le Beau to its advisory board. Le Beau was formerly head of marketing at Swiss Re before setting up the consultancy.

Bagger questions values

Standard Life carpetbagger David Stonebanks is taking the company to task over the way it used its institutional shareholder vote to reject Debenhams&#39 recent share offer. Standard Life Investments head of UK equities David Cumming was recently reported as saying the 425p a share offer for Debenhams undervalued the company against the sector and the […]

Revenue refuses to pay up for blunder

Personal and occupational pension schemes are facing losses of £82m after an Inland Revenue move to recover cash it had paid out in error as contracting out of Serps&#39 rebates. It has led to many schemes facing big shortfalls as falling investment markets mean the present value of the rebated funds is less than the […]

Insight offers two in one growth plan

Insight Investment has established the Insight investment growth plan, a capital-protected bond that caters for two risk profiles within one product. The accelerated growth option is designed for investors who are prepared for less capital protection in exchange for higher returns than the capital protected option, which is aimed at more cautious investors. Under the […]

Value for money in DC pensions

The Pension Policy Institute (PPI)’s recent report “Value for money in DC pensions” tries to identify factors by which people can assess whether their pension offers fair value for money (VFM). Fiona Tait provides an overview of the findings. Positive Outcomes It is extremely hard to assess VFM in a pension. Press activity naturally focuses […]


News and expert analysis straight to your inbox

Sign up


    Leave a comment


    Why register with Money Marketing ?

    Providing trusted insight for professional advisers.  Since 1985 Money Marketing has helped promote and analyse the financial adviser community in the UK and continues to be the trusted industry brand for independent insight and advice.

    News & analysis delivered directly to your inbox
    Register today to receive our range of news alerts including daily and weekly briefings

    Money Marketing Events
    Be the first to hear about our industry leading conferences, awards, roundtables and more.

    Research and insight
    Take part in and see the results of Money Marketing's flagship investigations into industry trends.

    Have your say
    Only registered users can post comments. As the voice of the adviser community, our content generates robust debate. Sign up today and make your voice heard.

    Register now

    Having problems?

    Contact us on +44 (0)20 7292 3712

    Lines are open Monday to Friday 9:00am -5.00pm