Active vs passive

The row between those who swear by passive fund management and active fund afficionados rumbles on and on. There’s no doubt which side is currently in the ascendancy, with passive funds growing faster than active funds in 2016.

Hold on a minute, though. New research commissioned by Aberdeen Asset Management suggests that what has practically become conventional wisdom may be wrong – at least when it comes to investment companies. Aberdeen asked an independent analyst, Fund Consultants, to study the performance of hundreds of closed-ended funds across a variety of sectors against the returns achieved by comparable passive exchange-traded funds. The actively-managed investment companies came out on top by an overwhelming margin.

Fund Consultants’ research covered more than 500 investment trust ordinary shares and 1,500 ETFs, with performance comparisons made in 19 sub-sectors over one, three, five and 10 years. The results varied a little by asset class, but the investment companies outperformed 53 per cent of the time over one year, 76 per cent of the time over three and five years, and 90 per cent of the time over 10 years. In fact, over that final time period, the only asset class where ETFs did better was US equities – a renowned tough beat for active fund managers.

What should we take from these numbers? Well, the report warns that the perceptions of investors are easily swayed by what’s just gone before. It cautions: “Investors may be influenced by the shorter-term data. Certainly, the popularity of ETFs can drive performance higher. If advisers are encouraging people to invest in index products and money is directed towards the sector, it means a lot of money is pushed into those companies that make up the highest weightings in the major indices. As such, it can be self-fulfilling.”

Equally, however, stock market performance tends to be cyclical. “Passive will have its moment when large caps or certain sectors outperform, but it may be temporary,” the report concludes. “It also suggests that the worst time to buy passive funds is when everyone is talking about the outperformance of passive.”

None of which is definitive, of course. You might summarise the report’s findings by saying that passive funds do better sometimes while active funds outperform at others. That’s also what you’d conclude from the research had it shown that passive funds more often came out on top.

The lesson here is that the active versus passive debate is not simple. No investor or adviser should automatically be ruling out one option or the other – there really is no substitute for doing your homework, looking at each fund on its own merits in the context of your broader investment needs and goals.

That’s not a palatable message of course. Most of us would prefer to be told that there is a right or wrong answer, because that makes life easier. However, the evidence of this research – just like previous research on the active versus passive debate – suggests that’s too much to hope for.