CONFRONTED by the statistics, it could be hard to argue in favour of active management. Very few active fund managers succeed in beating either the benchmark or their peers on a consistent basis. Research by Thames River Capital revealed that only 10 funds of the 1,065 with a three-year track record appeared in the top performance quartile in all three years.
Disillusionment with active management has been growing. Choosing an active fund did not protect investors from the worst of the financial crisis despite expensive fees and mediocre performance. Active funds naturally incur greater costs, making it more difficult for their managers to generate enough returns to offset the fees and create alpha for their investors.
Little wonder, then, that UK pensions funds and the like are increasingly recognising the attraction of passive investments. The Investment Management Association’s (IMA) latest asset management report showed that 23 per cent of institutional assets were passively managed in 2008. Saker Nusseihbeh, head of investment at Hermes, says that the active-passive debate is a primarily English issue thanks to the size of the UK pension fund industry – the second largest in the world after the US – relative to the small size of the main market. “The index size makes it much more difficult for active fund managers to add value,” he says.
Given all of this, it is tempting to wonder what place there is, if any, for active fund management. In Nusseibeh’s view, many pension funds still have too much exposure to what he would call core plus. These are ostensibly active funds but which perhaps only outperform the index by 1-1.5 per cent per year. After fees, the value of these funds is questionable.
The typical model nowadays, says David Norman, co-founder of tcfinvestment, is for sophisticated individuals to have the bulk of investments in a passive strategy but then have a satellite of racier investments where you really believe that the individual fund manager can add value.
A passive core of around 70-75 per cent gives investors exposure to the benchmark, which provides them with beta and allows them to devote the time and resources to selecting the best active satellite strategies.
There are some very successful fund managers out there but statistics would suggest that unfortunately they are the exception rather than the norm. Institutional investors should choose very high alpha active strategies that complement their low-cost core holdings and dedicate resources to finding a consistently good manager.