BLOG: Expediency versus expertise

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James Budden takes on the active versus passive debate.
BLOG: Expediency versus expertise

The venerable active fund manager Schroders recently bought a stake in the newbie Nutmeg. Nutmeg is a consumer facing investment platform which exclusively uses passive Exchange Traded Funds (ETFs) to build portfolios for its customers. Odd bedfellows you might think, unless perhaps Schroders see a day when Nutmeg can be converted from the passive path. However, it is easy to like Nutmeg as a concept. It delivers clearly explained, simply understood, investment solutions direct to the consumer at a reasonable price – a worthy aspiration. But fundamentally their offering will always underperform the index after fees. This is of course true of all passive funds.

Passive funds may well be cheap – take a look at those managed by Fidelity and Vanguard which track the UK All-Share charging only 0.07% and 0.15 per cent respectively. Nevertheless, they will always offer returns below that of the index. Yet this is the very same charge continually levelled at active managers by proponents of passive investing. They bleat that the average active fund manager always underperforms the index. They are right of course, but it is an odd and misleading statement; the average golfer does not win the British Open nor does the average tennis player win Wimbledon. The fact that average is not great does not mean the industry is totally rubbish. What the critics really mean is that many active managers deliver index-like performance but charge too much for it, whereas passive providers deliver below index performance at a cheap price (with some notable exceptions from a number of high street names).

Despite the sniff of hypocrisy lingering over the performance issue the critics are on the whole right about price. It is no good for active managers to deliver index like returns while charging five times the price (circa 0.75 per cent). The trouble is that many active managers are constrained by a culture that encourages short term thinking and herding and the old argument that you never get sacked for holding BP is at root of this failure. It is right to expose this racket and investors should vote with their feet. However supporters of passive investing are wrong to suggest that active managers who outperform cannot be found or if they do they are just lucky. Bolton and Woodford are two of Britain’s best known examples, but many others exist if you can take the time to find them. Perhaps this is the real problem: investors who don’t take advice from IFAs face a plethora of choice from thousands of funds with no real direction as to which are the good ones.

In the face of this, cheap passive investing appears an attractive option – and an easier one for the likes of Nutmeg to package and present. But the truth is that investors are actually missing out of the chance to enhance their returns. Those who are happy to put in the time and effort to explore the industry and unearth its winners may ultimately be handsomely rewarded.

James Budden is director of retail distribution and marketing at Baillie Gifford

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