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Picking a punch

The active v passive management debate has sparked many a war of words between tracker advocates and those who extol the virtues of stockpicking but the topic has lain almost dormant since Ron Sandler, in his savings review, argued that no correlation exists between charges and performance.

Although his contention that tracker funds, due to their low cost, are superior to actively managed funds sparked a wave of protest at the time – not least from the IMA, which rubbished his interpretation of the figures – the matter has gradually slid from the agenda. Although the bear market has highlighted trackers&#39 shortcomings in a volatile but ultimately static market, the argument used by tracker providers – that over the past 10 years, they have outperformed active funds – has stood them in good stead. Until now.

According to research by Hargreaves Lansdown, investors would be better off paying extra for active management, blowing out of the water the argument that trackers have done better over the past decade.

HL arrived at its conclusion by comparing the compound annual growth rate of all funds in the all companies sector over one, three, five and 10 years with the return from the FTSE All Share index. It then broke down this return – positive or negative – to give the outor underperformance for each 0.1 per cent of the annual management charge of every fund.

The results, which include what HL calls the “dross” in this most diverse of sectors, reveal that active funds outperform trackers in every timeframe from one to 10 years.

For instance, over one year, passive funds have, on average, outperformed by 0.14 per cent for every 10 basis points of AMC. In contrast, active funds have outperformed by 0.15 per cent. Although hardly a yawning chasm, the gap becomes wider over three and five years, when trackers slightly underperformed by -0.04 per cent and -0.08 per cent respectively. Over these timespans, active funds outperformed by 0.03 per cent and 0.02 per cent.

In fact, only over 10 years did active funds underperform, returning -0.05 per cent, but even then they trumped passive funds which returned0.08 per cent. director Ashley Clark believes the research reinforces the argument that most IFAs have been making to clients for years. He says: “It does not surprise me at all. Because of the bear market, institutions have been increasingly warning fund managers that, if they do not beat the index, they will be dropped as they are paying them for achieving very little. I think this has dripped down into the retail market.”

Clark believes the technological strides that have been made in research have also placed fund managers under greater scrutiny. But he feels the main problem that IFAs face is choosing which actively managed funds to put into portfolios. However, HL&#39s research goes so far as to pinpoint the top 10 managers over each timeframe, which has unearthed some interesting revelations.

The main one of these is the consistency of the top managers. For instance, the best-performing managers over 10 years tend to be the best-performing over five and, to a slightly lesser extent, also over the past three years.

GAM&#39s UK diversified fund, for example, is the top-performing fund over 10 and five years, with a outperformance per 10 basis points of 0.495 per cent and 1.116 respectively. It is also the second-best performer over three years although it has slid out of the top 10 over the last 12 months.

Fidelity&#39s special situations fund has also shown remarkable consistency, coming second over 10 years, third over five years and fifth over three years. In fact, eight of the leading 10 over 10 years are in the top bracket over three years.

HL investment manager Ben Yearsley says: “It is especially interesting to note that all funds in the top 10 for all the periods are genuine stock-picking funds. There are no closet trackers in there. Clearly, true active management is worth paying for.”

Yearsley does note, however, that there is a sizable discrepancy between the average outperformance of the top 10 lists and the overall average, highlighting the fact that there are many poor funds littering the sector. It is a point taken on by noted stockpicking house Liontrust, which app-lauds the validation of active management while sounding a note of caution over the timing of the research.

Marketing director Jona-than Harbottle says: “If this was five years ago, the boot would have been on the other foot. Far fewer fund managers would have been outperforming because it is easier for them to shine in a bear market. If you would have ditched TMT stocks in the first couple of months of 2000, even an untalented fund manager would have outperformed as the market was dragged down by its collapse.”

Tracker providers themselves make a similar argument. Virgin Money communications manager Erica Bell says the research does not make a definitive case either way.

She says: “Most actively managed funds will not outperform the market with any degree of consistency. With past performance being no guarantee of future performance, for most investors, choosing an active fund is still something of a lottery. We maintain that an index tracker should still form the core of most investors&#39 portfolios.”

While HL&#39s research paints a superficially convincing picture, there is obviously more to the debate than raw data. Trackers struggle in a volatile market but beat many active managers when the going is good. The key is timing and no IFA – let alone fund manager or computer – has perfected that elusive skill. Until they do, the argument will rage on.


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