Guest comment: Active funds are so passive – what’s going on?

Communications and Content managing director, David Butcher, discusses how active managers can wrest more control over the active versus passive debate

Unless you’re a contestant on Love Island, hidden from the cares of modern life, you probably know about the Woodford Equity Income Fund.

Just in case not … many investors, Kent County Council pension fund among them, are locked into a fund run by a former star manager – because he can’t sell stocks to meet redemptions.

If you read the small print you usually find a fund manager reserves the right to suspend a fund to protect pension scheme and other clients who want to stay.

But it’s the sort of thing you only really see actively managed funds doing.

Why? Because, unlike a passive fund that copies a liquid index of companies, a good active manager works hard to find investments that could do better than the market and avoid those that could do worse.

Except they never really talk about this with imagination, energy and purpose. They have a passive approach to communicating their advantages.

And there’s the problem. There’s a lot of good stuff that active managers do for their pension scheme clients that rarely gets said.

They remind me of Harry Enfield’s 1990s spoof DJ, Dave Nice, whose celebrity friends “do a lot of work for charity, but don’t like to talk about it”.

So, here are three things active managers could start talking about right now to wrest more control of the active versus passive debate – from an experienced and disinterested consultant to the industry.

First, an active fund exists to do better than the market – while a passive fund will always lag the market, after fees.

For example, we all know there’s a pile of academic research saying active fund managers lack consistency. In short they sometimes beat the market, but sometimes don’t – and that can make them poor value for the fees they charge.

But where’s the academic research or empirical evidence that talks up the value of a good active manager?

I haven’t tried my hand at academia for many years – though I might use academics to help my clients tell stories – but to my mind, it could go like this:

You need a decent standard of living in retirement, and the money you save needs to grow at a rate above that of inflation as market growth alone is unlikely to be enough. One answer lies in trying to find companies and other assets with the potential to keep ahead of inflation and other risks and that’s where active fund management comes in.

Why don’t we see this argument everywhere? It’s uncomplicated, simple and effective.

Second, there’s a vast body of human evidence that active management works.

There’s half a billion people in the EU – and around one in five of them is over 65. That implies a large number of retirees.

Now, I don’t know how many of them were helped to an acceptable standard of living in retirement by active managers, in DB schemes and other savings, but I’ll bet it’s a large number. And once you start thinking about all those people – you can start to think about the stories of how they saved and invested and were helped towards retirement goals.

What someone needs to do is start looking at people’s stories – and their data – and start building that into a compelling narrative: “active management worked for me – and it can work for you too”.

Third, active funds are still pretty much the default holding – and will be for a while.

In the UK at least there’s around £7.7trn in managed funds – and the split is around £3 active for every £1 in passive funds. True, the ratio used to be around £4:£1 as recently as a decade ago, but that comes after the financial crisis helped reduce trust in financial professionals.

It’ll take some time before we see anything like £1:£1 parity.

And, even if we did, we should consider the very challenging systemic implications for so much money slavishly allocated to big, powerful corporations and so little to up-and-coming or private companies.

Perhaps there was too much money allocated to active in the past? Perhaps a prolonged bear market will reverse a trend of money switching from active to passive?

Who knows?

It would be better for innovation and debate in the investment management sector if we saw more of the case for active management. It just needs to be made actively.

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