THE RELEVANCE OF PASSIVE FUNDS WILL CONTINUE TO GROW

Duncan Gourlay, The Herald




SUMMARY

Duncan Gourlay, Head of Weatherbys Private Bank's Scottish Office, spoke to The Herald to explain why he believes the relevance of passive funds will continue to grow.

This article was first published in The Herald on 17th August 2019.
Read the original article by clicking this link.

THE HISTORY OF PASSIVE FUNDS

The big investment story of the 20th century was the professionalisation of money management.

Until then investors had taken a do-it-yourself attitude to their portfolios, but from the 1920s onwards they began to put their faith in fund management houses instead.

As the new millennium dawned, however, yet another innovation in finance started to take-off that meant investors no longer had to pay through the nose for the services of a manager who would inevitably end up loosely tracking the market.

With the advent of passive funds, which track the market by investing in every company in it, it was possible for investors to cut out the expensive middle-man.

This allowed even small investors to access the market efficiently.

These so-called tracker funds have continued to grow in popularity since, but does that mean that traditional fund managers’ days are numbered?

If decisions were based on cost alone that would certainly seem like a likely outcome.

Recent figures have confirmed that tracker funds are set to account for half of the US stock market by 2025. This is perhaps unsurprising given that, while the fees on some active funds can be one per cent or more per annum, some trackers charge nothing at all.

CAN ACTIVE MANAGERS JUSTIFY THEIR FEES?

Active managers justify their fees by taking big investment decisions on your behalf.

Essentially, when you invest through an investment manager, they will do two things.

First, they will decide which shares, bonds and funds to buy - trying to pick the best ones while also trying to time the markets – and, secondly, they will decide when to get in and out of the stock market, including when to switch to bonds and other assets and which geographical regions and sectors to invest in.

The first of these activities is generally called stock selection while the second is referred to as market timing or tactical asset allocation.

PASSIVE FUNDS ARE THE SOLUTION

It is a well-established fact that most fund managers and, one may reasonably assume, most investment managers in general perform worse than the markets in which they invest over relevant periods of time.

For example, according to recent research by Standard & Poor’s, 73% of UK equity fund managers did worse than the general market between the end of 2008 and the end of 2018.

UK-focused managers actually did rather well compared to global equity managers, 92% of whom underperformed over the same 10-year timeframe.

To anyone steeped in finance research, none of this is any surprise. The first academic paper that we know of to find that most managers underperform “the general run of stocks” was published in 1933, and its main finding has been repeatedly confirmed over the last 86 years.

The lower costs involved in passive funds compared to active managers help them deliver better post-fees performance over the long run.

Some investors accept that stock selection is a challenging enterprise, but nonetheless employ investment managers because they want them to sell out of markets before a big fall. The notion that investment managers protect capital in bad times by market timing is widely held – but false. There is less academic research in this area, but what there is tends to support the view that market timing defeats most managers.

WEATHERBYS & YOU

Managing wealth is complex but it can be made simpler with four crucial checks: understand your needs; set clear investment goals; agree a long-term strategy; and conduct regular and thorough reviews of your investments.

A low-cost passive solution can help to lower charges and reduce stock-specific risk. Using tracker funds ensures that portfolios are truly diversified, giving access to the full universe of bonds, global stock markets and cash in one simple, straightforward package.

The jury is out on whether fund managers’ days are numbered but it is clear that tracker funds, which can offer investors an alternative investment solution, are becoming increasingly more relevant in the UK.

Past performance is not a guide to future performance. The value of an investment and its income can both increase and decrease and you may not get back the full amount originally invested. The value of overseas investments will be influenced by the rate of exchange.

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