Active encouragement for fund managers

A number of eye-catching recent statistics have reignited the ongoing debate around active vs. passive investment. Passive funds now account for 35% of all mutual fund assets in the US, up from just 2% 20 years ago. As illustrated in the Financial Times charts below, in 2014 less than 15% of US large-cap mutual funds outperformed their benchmarks, marking a low point for an industry under increasing scrutiny. 




When even Warren Buffett is telling his wife to put 90% of his fortune into an S&P 500 tracker fund after he dies, it’s difficult not to pay attention.

Morningstar recently posted an interview discussing some of the key reasons behind the growth of passively managed funds during the last 12 months. The 3 main themes highlighted are:

  • Lower-cost products
  • Wider choice of index funds
  • Strong global index performance

To a certain extent, these themes go hand in hand – the better the main indices perform, the more interest passive funds generate and the more products are tailored around them. With returns under greater scrutiny than ever, the cost advantage to index investing from a fund management point of view looks increasingly attractive to investors.

Vanguard’s own blog puts the role of these costs into perspective. Given the small margins, reducing the execution cost of the actively managed fund significantly increases the likelihood that it will outperform the benchmark. In fact, for funds with a cost lower than 50 bps this number rises to 39%.



Perhaps inevitably, 2014 saw a substantial increase in the prevalence of alternative investment strategies such as smart beta. These strategies are a logical half-way house, offering investors the lower-cost security of index investment with the flexibility of an active weighting strategy. It may be too early to evaluate the long-term success of this approach, but after such a difficult year in the press, active fund managers are increasingly taking advantage of the additional opportunity to demonstrate that skill still has a huge role to play in chasing alpha, even if this does herald a more general trend towards cost reduction across the investment management industry.

Closet tracking

Many have pointed to the dubious practice of ‘closet tracking’ as a drag factor on active investment return figures. Closet trackers are actively managed funds which track the index either entirely or to a significant extent, meaning that investors lose out on both counts, as they are charged high fees for what are effectively passively managed funds. In fact, Informed Choice point out that over three quarters of the IMA UK All Companies sector funds correlate with their benchmark index to a degree of 90% or more. An FT article recently highlighted that as much as a third of actively managed UK funds can be classified as such. Some correlation is probably a good thing, particularly given index performance in 2014, but given the higher fees there comes a point where it makes more sense for investors to bypass the middleman and go straight for the index.

The case for active management

Active and smart beta funds still offer some obvious advantages over their passive counterparts. A Times article published on Saturday cites a study by HFM Columbus which suggests that active funds in the UK have actually prospered during the last 12 months, although the study does not take into account the execution costs of the respective strategies.

The article highlights the fact that control over investment provides protection against macro industry trends such as the falling oil price, as the performance of companies like BP and Royal Dutch Shell drag indices down and provide the active fund manager with an opportunity to outperform. The strong performance of small- and mid-cap stocks in 2014 also offered investors a good alternative for getting ahead of the market. Skilful fund managers continue to exploit this opportunity to good effect to stay ahead of their benchmarks. As the Novel Investor chart we posted up over the weekend shows, emerging market equities are the other big performers as an increasing number of active fund managers look internationally for value. Opportunities are often found within segments of the market not covered by mainstream research analysts. 

The wider performance margins emerging markets and SMEs offer can reduce the impact of execution costs for high return funds (the impact of macro trends can be similarly amplified). The higher volatility of these stocks coupled with a more lenient disclosure environment and an often unpredictable economic or political climate means that it’s particularly important for investors to be actively engaged with the companies in their portfolios, and to stay on top of and react to the latest developments to maintain an edge over their passive rivals.

If they can manage this, 2015 may yet be the year of the active investor.

470 thoughts on “Active encouragement for fund managers”

  1. Its like you read my mind! You appear to know a lot about this, like you wrote the book in it or something. I think that you can do with some pics to drive the message home a bit, but instead of that, this is wonderful blog. A great read. I will certainly be back.


  2. Thanks, I have recently been looking for information about this subject for a long time and yours is the best I’ve discovered so far. But, what about the conclusion? Are you positive in regards to the source?


  3. Hands down, Apple’s app store wins by a mile. It’s a huge selection of all sorts of apps vs a rather sad selection of a handful for Zune. Microsoft has plans, especially in the realm of games, but I’m not sure I’d want to bet on the future if this aspect is important to you. The iPod is a much better choice in that case.


  4. What i don’t realize is in truth how you’re not really a lot more neatly-preferred than you may be right now. You are so intelligent. You recognize thus considerably in terms of this subject, made me personally imagine it from a lot of various angles. Its like women and men don’t seem to be fascinated until it is one thing to do with Woman gaga! Your personal stuffs excellent. Always take care of it up!


  5. I do accept as true with all of the ideas you’ve offered for your post. They’re very convincing and will definitely work. Nonetheless, the posts are too quick for newbies. May just you please lengthen them a bit from next time? Thank you for the post.


  6. Hello there! This post could not be written any better! Reading this post reminds me of my old room mate! He always kept talking about this. I will forward this write-up to him. Fairly certain he will have a good read. Thank you for sharing!


  7. I intended to write you that very small word to thank you very much again on the remarkable advice you’ve shared above. It was simply incredibly open-handed of people like you to supply freely all a few individuals could possibly have offered for an e-book to end up making some profit on their own, principally since you might have done it if you ever desired. These strategies additionally acted as a good way to fully grasp that other people online have the same dream much like mine to learn lots more with reference to this matter. I believe there are a lot more fun opportunities in the future for folks who discover your site.


  8. I loved as much as you will receive carried out right here. The sketch is tasteful, your authored subject matter stylish. nonetheless, you command get bought an shakiness over that you wish be delivering the following. unwell unquestionably come further formerly again since exactly the same nearly a lot often inside case you shield this increase.


  9. Hello, you used to write magnificent, but the last few posts have been kinda boring¡K I miss your tremendous writings. Past several posts are just a little out of track! come on!


  10. Whats Going down i am new to this, I stumbled upon this I have discovered It absolutely useful and it has aided me out loads. I am hoping to contribute & assist other customers like its aided me. Good job.


  11. A lot of thanks for your entire efforts on this website. My niece enjoys making time for investigation and it is easy to understand why. Most of us notice all relating to the compelling method you give worthwhile items on your web site and even strongly encourage response from others on that situation then our own princess is really understanding a great deal. Take pleasure in the rest of the year. You’re the one performing a wonderful job.


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s