Passive vs Active

It has been an interesting time setting up Altor, initially there was a 6-month imposed period of paid purdah and time to reflect. With some of the spare time allowed us, we began researching the best way to return consistent risk-adjusted growth for our clients.

With no preconceptions we set about comparing all of the discretionary fund managers’ performance that we could find (including the one who put us in purdah).

Our starting point was to benchmark them on a risk-adjusted basis (taking into account both the risk they were running and the return delivered) against a series of passive funds. It seemed like an obvious thing to do, as why would you pay a discretionary manager if they couldn’t outperform the cheaper alternative way of accessing the returns on shares, gilts and corporate bonds?

After much number crunching it soon transpired that very, very few were outperforming the passive option over the short or medium term.

Now it turns out that many people seem to have been also coming to this realisation recently (the evidence has existed since the 70s). As an example Vanguard (the original passive index company) received the most investments last year of any investment firm with net inflows of $200billion in 2016, over four times its nearest rival. In fact a lot of money (billions) in the last few years has been flowing from the active management firms to passive management firms. Since 2007 in the US, active funds have experienced growing net outflows and a lot of the money seems to be flowing to passive index trackers or exchange traded funds (ETFs), peaking in 2016 with -$1,200 billions US active vs +$1,400 billions US passive.

In the UK you can buy a very diverse spread of passive global investments for 0.22% per annum whereas an active equivalent is likely to cost you in excess of 1% per annum (and can cost you 2% per annum plus). Basic economics suggests that anything that costs 5-10 times as much and isn’t as good, will not last very long but we have a long way to go as circa $8trn sits in active funds still.

Perhaps the last 8 years of near bull market returns have been too generous to passive funds and maybe active managers will start earning their money as markets correct, only time will tell.

Given all this what have we decided to recommend to clients?

Well it is simple; passive investments should form the core of most client’s portfolios (unless they are ethical – the passive industry has some way to go on this) but there is a satellite place for the discretionary managers who can match index returns if they offer something different by diversifying (into property for example) to reduce risk and volatility.

And the ‘star’ fund managers that clients want to still hold on to (Fundsmith and Troy seem to be flavour of the moment whereas when I started 16 years ago it was Anthony Bolton and Neil Woodford)? Well that is fine provided they don’t mind being shown the stats, year in year out by their Altor adviser.

Want to read more (of the stuff we read)?

Dow Jones run a fascinating and beautifully illustrated annual report on this subject –

Robin Powell campaigns on this and can be found here –

And here –

Chris Newlands of the FT has written extensively about this –

Fascinating article from James Kwak at Baseline Scenario

This is worth a read from Credit Suisse –

William F Sharpe from 1991 (to prove that this isn’t a modern phenomenon) –

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