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Brian Tora: Passive vs active debate is increasingly complex


I was privileged to chair an interesting debate at the London offices of JM Finn & Co last week. The theme was active versus passive and it made me realise how much progress had taken place in the field of index tracking investment products.

No firm conclusion was reached – nor was any sought – but it did serve to remind the audience of independent financial advisers and discretionary portfolio managers of the wide range of options now available.

It happens that I was involved with the launch of some of the earliest retail index tracking products. Not the very first, sad to say. Tony Fraher, who was then running the Morgan Grenfell investment funds business, pipped us to the post. “Us”, at the time, were the team running James Capel Unit Trust Management, where I was marketing director. Nigel Legge, who went on to found Liontrust, ran sales and our MD was Jonathan Custance Baker.

Our plan to launch easy access index tracking funds was nearly scuppered by the firm’s research department.

At the time James Capel (which had already been taken over by HSBC and was soon to see its venerated name disappear), enjoyed the status of being the top rated research house in London – a position that was hard won and jealously guarded. Research, in the view of those analysts who had succeeded in propelling the firm to its number one position, was all about adding value. Indexation required no such edge. So we were stalled in our ambitions, until one of our larger clients, which used one of our actively managed funds for its customers’ Personal Equity Plans, insisted that best advice demanded an indexed solution.

I am, of course, talking about a quarter of a century ago but we could see their point. And so our first index tracking vehicle was launched, closely followed by others of an increasingly complex nature.

I have told the story before of our Tiger Tracker – a fund designed to replicate a composite index of several small Far Eastern markets – and the difficulties this presented. Back in the late 1980s exchange traded funds had yet to appear, but they have now been around for over twenty years and have grown massively in popularity and thus size.

Moreover, the range of assets that can now be tracked by an ETF is impressively – frighteningly even – large.
Given that active management is arguably a zero sum game, with every winner demanding a loser to balance it out, and given also the costs attached to running active funds, the arguments for the passive approach are powerful.

The lower costs attached to an ETF alone enhance their attractions but I still find it hard not to be a supporter of active management. But the passive lobby has gained in power over recent years and cannot be ignored.

Perhaps there is a case for using passive vehicles when making tactical asset allocation decisions or when a case for an active fund becomes hard to justify.

One of my colleagues made just such a point last week. He had taken the decision to dump an active fund providing specific regional coverage but chose to secure cover through an ETF while research into a suitable actively managed replacement was completed. But the increasing complexity of passive vehicles must surely mean they require the same research commitment as any other fund.

There is room, I am certain, for both approaches when it comes to constructing portfolios for private investors.

Whether you take the core/satellite approach, use ETFs for tactical asset allocation calls, access asset classes that demand an indexed solution or simply substitute passive for active as a holding measure, they can be very useful. But the consequences of indexed vehicles marginalising active managers could be very serious indeed.

Brian Tora is an associate with investment managers JM Finn & Co


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