For years, the argument between active and passive management has raged, with devotees of both approaches claiming victory! Today, passive investment represents c. 15% of total assets under management globally (higher in the USA) and this is expected to continue to rise as the focus on low management costs grows. In the UK, the introduction of the charge cap for Defined Contribution default strategies has encouraged a greater focus on passive mandates, as pension schemes adapt to the new lower charge regime.
Is it, therefore, time to question the benefits of active management?
At university we were taught the principles of the efficient markets’ hypothesis, which was established in the 1960s and which states it is not possible to consistently outperform the market, as share prices quickly incorporate and reflect all (known) relevant information. Thus, investors will struggle to purchase shares that are truly undervalued, or be able to sell for prices above their true value.
However, at several points over the last year alone, we have seen periods where the market has behaved irrationally – whether in response to an early morning tweet from the President, which sees individual company’s share prices swing, or where whole sectors are driven by “herding” or “FOMO” (Fear of Missing Out).
Greater focus on charges
Today when discussing active versus passive mandates, I rarely find clients interested in the efficient markets’ hypothesis, or the latest thinking of renowned economists. Instead, I find far greater importance is placed on the fees charged by active managers and the perceived better value of passive funds with lower charges.
The Pensions Policy Institute’s impact of DC asset pooling report, published in November 2017, covers this very point – unsurprisingly, their findings show that higher charges can negatively impact members’ funds. Although, improved investment returns have a significantly greater impact – the question here is whether active management can deliver better long-term returns.
It would also be fair to note that passive funds tend to have greater appeal in extended periods of rising markets with lower volatility, such as we have experienced for the last several years. It is perhaps when market volatility rises that active management becomes more highly valued, potentially providing the risk-management capabilities an index-tracking fund is likely to lack.
Conclusion
In our view, whilst some markets have been identified as highly efficient, the collective behaviour of investors can lead to pricing irregularities that provide profitable opportunities for dynamic and active managers.
Further, we do not believe you have to sit in the active or passive camp – we see great merit in using both approaches in different markets and believe an efficient portfolio can be designed which encompasses both strategies to the benefit of clients.
Amanda Burdge, Principal Investment Consultant at Quantum