When Should You Opt for Active Funds?

In rising stock markets it is difficult for active fund managers to prove their worth. But in flat or falling stock markets they earn their fee

Emma Wall 4 June, 2015 | 11:30AM
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“Asset managers are very good at pushing products down investors’ throats – they need to spend more time on education,” says Katherine Garrett-Cox, chief executive of Alliance Trust.

Passive investing is momentum investing

Garrett-Cox was speaking at the recent Morningstar Investment Conference in London, where she revealed that on the Alliance Trust Savings investment platform seven out of the top 10 selling funds were passive. The Veuve Clicquot Business Woman of the Year said that all too often active fund managers and their parent groups were too concerned about the fees flowing into their pockets rather than delivering the best possible result for the end investor.

“In 2013 the most popular funds on the platform were actively managed, last year there was a shift and the top selling funds are passive,” she said. “People have lost faith in active management in part because of fees. What you pay for a fund matters – it affects long term returns.”

This is not to say that active management cannot be achieved at a lower price point. Garrett-Cox said it was “rubbish” that active management could not be achieved for less than 0.75%.

This threshold is particularly important as it is the new charge cap applied on pension funds – and many active managers have said they are unable to run money for this price.

The Benefits of Active Management

Helena Morrissey, chief executive at Newton Asset Management agrees that part of the problem is lack of education.

“We’re not doing a great job of contextualising what we do,” she said of active fund managers. “According to a recent survey only 12% of the population trusts fund managers. We need to be better at explaining how we help businesses grow and prosper which in turn that helps employment and the economy – and how we also help investors to prosper along the way.”

Morrissey says that it is more important than ever for investors to understand the benefits of active management as stock markets slow.

“When markets are rallying such as they have been doing over the past five years it is difficult for active managers to differentiate themselves. Economic growth in developed markets has supported global equities, along with cyclical trends of aging populations and more wealth in emerging markets. This has bred inertia, but we need to keep ourselves in check,” she said.

Passive investing is momentum investing – it forces you to buy high and sell low, which is why education is needed for retail investors. In the event that stock markets move sideways – or there is a correction – good active managers will prove their worth and preserve investors’ capital.

But Morrissey admits many investors need to be convinced of the benefits of active management.

“Active managers have to be much more visible, be part of investors’ lives and helping to improve their financial health,” said Morrissey. “You can’t just say ‘trust me’ we have to be patient.”

Investors Have Become Too Short-Termist

As well as a new focus on fees, there has been a fundamental shift in how long investors hold a fund for. While demanding value for money is a good thing, becoming too short-termist can be damaging for your portfolio.

“There is a worrying trend among some investors to want positive returns within a week of investing,” said Garrett-Cox. “From 1940 to 1970 the average holding period for an investment was seven years. After the credit crisis this dropped to just seven months. Now it is around two years – but for many asset classes this is not a long enough horizon.”

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Emma Wall  is former Senior International Editor for Morningstar