Active versus passive management

Where do you stand on the debate about active versus passive management? It’s an argument that goes to the heart of how you choose investment funds and what you think the job of an investment manager really should be.

In one corner is the passive sector. It argues that so many actively-managed funds fail to beat the market on anything like a consistent basis that it there is little point in putting your money into a vehicle that is more likely than not to underperform the average return generated by the assets in which it invests. All the more so since you’ll generally be required to pay expensive charges to access an active fund (which is one reason it may underperform).

In which case, why not simply invest in a fund that aims to track the market – to replicate the performance of a specific market index – and comes with the lowest possible charges? This way you’ll at least be guaranteed not to underperform the market by a significant margin and you won’t be paying through the nose for what could turn out to be a dud fund.

The counter argument is that this lacks ambition. Active fund managers point out that not all of their kind underperform – there are plenty of funds that can demonstrate lengthy track records of consistently beating the market, even after the effect of higher charges. Past performance may not be any guide to the future, but the evidence of historical fund data is that it is possible to do much better than an index tracker if you’re in the right funds.

Stalemate is the word that probably best describes where we have got to with this debate. It’s been raging for decades without either side striking a decisive blow – not least because both arguments have their merits.

So where does that leave investors? Well, it’s worth pointing out that active and passive fund management don’t have to be mutually exclusive. It is increasingly common for investors to use passive funds as the core constituents of their portfolios but then to add actively-managed funds in order to broaden their horizons. And it’s possible to do this within the investment companies sector, paying competitive charges on both types of fund.

In fact, the sector contains relatively few index trackers, because the additional costs of having your shares listed on the stock market make it harder to offer super-low charges. However, investors do have several options - not least Aberdeen UK Tracker, which has just cut its annual management fee to 0.14 per cent a year.

In fact, the idea of using an investment company to track the market is an interesting one. The value of its shares will sometimes trade at a discount or a premium to the value of the assets that the fund holds – because the share price is determined by demand and supply. So while the assets will track the market closely, the share price may do so a little less accurately – a fund trading at a discount may even beat the market it tracks if the discount narrows.

As for actively-managed funds, there is no reason to pay through the nose, even for a well-managed portfolio of international equities. In the global growth sector, for example, Independent Investment Trust, Scottish Mortgage and Law Debenture all charge an annual fee of less than 0.5 per cent – and all have outperformed the market consistently over medium and long-term periods.