As passive funds gain in popularity, we need active and opinionated investors more than ever

 
Julian Harris
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Warren Buffett (right) won a $1m charity bet against the performance of hedge funds (Source: Getty)

Among the most famous bets made by stock-pickers in recent times was Warren Buffett’s million-dollar wager, settled last year, that hedge funds would underperform the wider stock market over a 10-year period.

In the end, the outcome of the bet was not even close. And even though hedgies were able to point to an exceptional period of share index performance driven by historic levels of central bank stimulus, Buffett’s win was undeniably embarrassing.

But are hedge funds bouncing back? The industry produced its best returns since 2013 last year, with some funds on this side of the pond boasting their own high-profile victories. Sharp drops in the share price of big companies such as Provident Financial, the now-defunct Carillion, and – more recently – Capita were all notable for the accompanying paper profits enjoyed by audacious hedgies that had shorted the stock.

Read more: Carillion's crash shows the value of studying the firms in which we invest

Meanwhile, the UK’s most famous long-term investor, Neil Woodford, has endured a torrid time, partly due to his exposure to the aforementioned doorstep lending and professional services firms. There is no love lost between traditional steady-as-she-goes style investors such as Woodford and Mayfair’s more shoot-from-the-hip type hedgies – and the latter are certainly enjoying his recent struggles.

These tiffs between different breeds of investors are nothing new, and there is no sign of the arguments dying down. For this, we should be grateful.

A lively debate on the effectiveness of the investment industry is crucial to improving a sector on which millions of people depend, typically through their pensions and other savings.

It has shone a light on excessive fees, for example, which may finally start to be eroded.

Read more: Latest Mifid hiccup: Esma delays revealing stocks affected by volume caps

Such fees have pushed people increasingly towards passive investments – an understandable reaction but one which could stoke volatility. Markets live and breathe on the availability of information, and there are legitimate concerns about declining levels of analysis, potentially worsened by the latest phase of Mifid.

For the market to be remotely efficient, we need a large number of people making highly-informed decisions. Whether they are in it for short-term gain or seeking out long-run fundamentals is up to them. It makes sense for passive investors to piggy-back on this activity, but if the balance between those being carried and those doing the carrying moves too far, we may have a problem.

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.

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