The weakness of the Pimco fund is perhaps not surprising. The fund is significantly invested in fixed interest and investors no longer see much value in the asset class. The Vanguard fund, in contrast, has been a significant beneficiary of the increased popularity of equities, drawing inflows of $14.5bn in contributions this year, including $2.1bn in October, according to Morningstar data.
The move to passives is being seen elsewhere. iShares recently reported an uptick in the amount of iShares assets held on wrap platforms, suggesting that ETFs are gaining greater traction with financial advisers after the introduction of the Retail Distribution Review.
It had £1.05bn held on nine wrap platforms as of the end of the September 2013, a growth of 23% compared with the end of 2012. Legal & General has also reported a growth in retail passive funds.
It has become vogue-ish among wealth managers to say that asset allocation is the only game in town and in this context, passive funds fit the bill perfectly. They are cheap, exposure can be targeted and they are liquid. Asset allocation shifts can be made quickly.
More recently, there has been another advantage to passive funds – they are indiscriminate in where they invest. Many of the top-performing stocks and markets this year have been those that no rational investor would touch – the National Bank of Greece, for example, or the Greek stock market as a whole.
In contrast, the departure of star managers such as Neil Woodford and Richard Buxton has made active funds look vulnerable. If investors can’t rely on the star fund managers to stick around, why not simply invest in passives and avoid the risks?
However, active funds still have the edge on performance. Over the past year, for example, the FTSE 100 is up 15.2%, while the average UK All Companies fund is up 25.9% and the average UK Equity income fund is up 25.5%. This is in a rising market when passive funds are supposed to come to the fore. Over three years the performance differential is even more marked – the FTSE 100 is up 16%, while the average UK All Companies fund is up 37%, and the average UK Equity income fund is up 39.8%.
There may be a number of reasons for this – a higher weighting to top-performing small and mid-cap stocks, for example. However, it does suggest that investors write off the active sector at their peril. Certainly correct asset allocation is vital in determining long-term returns, but with some 82% separating the top and bottom performing funds in the UK All Companies sector, it is clear that value can be added through correct fund selection as well.
As ever, the best solution is likely to be somewhere in between the two. It is beholden on wealth managers to find ways to deliver strong client returns in line with their objectives. There are ways to do this through both asset allocation and correct fund selection. Both the active and passive fund industries have their place and while the passive industry is in the process of catch-up in the UK, it is unlikely to dominate just yet.
