David Prosser discusses what actively managed funds can offer investors and where they should begin.
Is the tide turning in the active versus passive management debate? For much of the past five years, the flow of investors’ money into index-tracking vehicles has seemed inexorable, prompting predictions that passive funds would soon eclipse their actively-managed counterparts. But in 2021, the mood has changed: in 10 of the past 12 months, active funds in the UK have raised more new capital than passives, says the analyst Calastone; and October saw record outflows from the latter.
One driver of this shift is market sentiment. Anxiety has been building all year about the sustainability of the strong performance of global equity markets; and while equities posted good returns in October, investors became increasingly conscious of the threat posed by inflation and the prospect of higher interest rates.
For those worried that the markets are set for tougher times, passive funds are not the place to be. Who wants their money invested in a vehicle that has no choice but to blindly follow the market downwards?
Another factor in active funds’ return to favour is the ongoing rise of investment with an environmental, social and governance (ESG) tilt. Indeed, the ESG star has risen even more quickly than that of the passives. Research from consultant PwC predicts three-quarters of institutional investors will stop buying non-ESG funds from next year onwards. There are tracker funds with an ESG focus, passively following the growing number of bespoke indices, but for most investors, ESG intuitively feels like an active pursuit.
All of which begs a question. If active funds deserve another look, where should investors and their advisers start the hunt?
There will be lots of answers, but it is worth considering research published last month by the investment platform Interactive Investor. It pointed to no fewer than 42 investment companies that have multiplied investors’ money ten times over or more over the past two decades. That implies they have delivered compound annual returns averaging at least 12.2%.
To put those figures into context, blue-chip UK stocks have risen by around a third over the same period. In other words, in a passive fund tracking the top end of the UK stock market, you would not even have doubled your money during a period when these 42 investment companies were multiplying it tenfold.
The identity of those “ten-baggers” is remarkably varied, ranging from technology-focused funds to Asian specialists and private equity funds. Some of the investment companies in question, notably Scottish Mortgage, are very large; others are much smaller. In general, a focus on smaller companies rather than large-cap companies has prevailed, but not in all cases. Most of these funds have seen ups and downs along the way – volatility has often been one price of superior performance – but patience has been rewarded.
The list is a ringing endorsement for active investment management, a strategy that the investment companies sector pursues almost exclusively. It is a reminder that for all the noise about fund managers charging high fees for mediocre performance – or worse, running closet trackers that more or less follow the index but levy active charges – there are plenty of managers out there delivering on what they have promised. Very often, the investment companies sector is the place to find them.
If the shift into active funds this year reflects investor anxiety that we may be in for a rough ride from equity markets in the months ahead, that is understandable. But the record of leading investment companies proves that active funds can also be a good option in rising markets.