Active or passive global equities?

Herbalus

I recent joined a large company and started pension contributions, for which they have a number of funds available. Although I have read Tim Hales' book and been around these boards + monnevator newsletters for a few years, I've never invested before. Seeing as I'm only putting in about 30% of my pension fund (tax breaks plus employer contributions), and have a very long term horizon, I'm happy for the higher risks of global equities.

My question is whether it's likely to be more advantageous to have the managed fund as opposed to the passive fund as the charges of the fund are met by the employer. I've been convinced over the years that low charges, the part that you can control, are key to good returns due to the power of compounding, plus the data that backs index returns over more costly managed funds, but is this still the same if I'm not actually the one paying the costs?

Additionally, the graph for the passive fund shows the fund beating the index by a small margin over the last 12 months. I was aware that a fund will not be exactly the same as the index it holds, but I thought it would only be slightly lower?

brendon

I assume the employer meets the annual management charge? This doesn't take into account the trading costs of the fund, which are a lot lower in large passively managed funds. What sells active funds is the idea that 'you get what you pay for'. You've made the assumption that because a fund is expensive, it must offer superior returns. This logic is flawed, whether you or somebody else is paying the fee. The combination of all funds and transactions *is* the 'market', and there's no way of determining who will over- and under- perform.

Glen_Clark

If you can buy into the managed fund at a discount as you can in most investment trusts, the fund managers may be a liability that is already priced into the shares.
I didn't find this point in Tim Hales 'Smarter Investing' book.

Herbalus

brendon wrote: »

What sells active funds is the idea that 'you get what you pay for'. You've made the assumption that because a fund is expensive, it must offer superior returns. This logic is flawed, whether you or somebody else is paying the fee.

Yes, I agree with that statement. I know the market return is the sum of all those beating the market and those losing against the market, and that the costs of the fund mean that a manager has to beat the market by his costs to just be average. So in effect a manager who performs the market average will be lower than the market because of his costs.

But if the management fee is free to me, then a fund manager would surely have a 50:50 chance of beating the market, as there must be an equivalent percentage above and below the market?

I know that on each of the figures for the past 5 years, the managed fund has higher percentages, so more growth and more loses: it's more volatile. I just wondered if it'd be better to opt for a managed fund as the cost of the fund, which is the main argument for trackers, is not a variable here.

jimjames

Are you sure the company are paying the annual management fee of the fund and not just covering the cost of running the plan ie the platform fee?

The AMC is normally part of the fund price so not charged separately unlike platform cost.

kidmugsy

brendon wrote: »

What sells active funds is the idea that 'you get what you pay for'.

And that idea demonstrably isn't true in investing. The performance of active managers over the years is sufficiently close to blind chance that it's long odds against an investor finding a manager with persistently superior performance.

bowlhead99

kidmugsy wrote: »

The performance of active managers over the years is sufficiently close to blind chance that it's long odds against an investor finding a manager with persistently superior performance.

To an extent, that depends on what you are looking for, because 'performance' can be taken to mean 'success at meeting an objective'.

Your objective may be "a decent return with lower volatility than an index of stocks weighted on market capitalization";

Your objective may be to receive high monthly income payments while being exposed to both equities and bonds;

Your objective may be to get your returns ethically, avoiding certain industries;

So, investing in one single index may not perform as well as active management. If you look at constructing a portfolio out of multiple indexes to meet objectives, you are getting into active management because you are choosing the proportions (or with a fund-of-funds, someone else is being paid to choose the proportions).

And arguably if you decide indexing is the way to go, then isn't the performance of one index over another 'sufficiently close to blind chance' to make it difficult to choose the index in which you invest? For example what is the performance going to be over the next year, for the US Wilshire 5000 stockmarket cap-weighted index versus an index equal weighted at today's ratios? It is an unknown.

Or what is the performance going to be for the UK 100 vs the UK 250 vs the UK Smallcap? In the boom times we would expect smallcap or UK250 to do better than UK100, because of growth potential - while vice versa in the bear times. Over a lifetime, there are more years growth than contraction. So if you have a lifetime to invest, you might prefer the UK250 and smallcap and not use the UK100 at all.

However over shorter time periods you don't know which will be the best so you should probably hold all of them. Maybe £1000 in each for your £3000 UK equities portfolio. However, that would get you a very different result than buying an UKAll-share index which puts £100 in UK smallcap, £475 in UK250 and £2425 in UK100.

"Why!" Asks the punter, "would I be so dumb as to put £2425 into the FTSE100 and only £100 into smallcap, when most commentators are confident that smallcap and midcap would outperform megacap over a whole lifetime of investing, and I can see that the industry sector concentrations in FTSE100 are massive compared to the other two indexes and I don't know if oil and tobacco are going to be so relevant over a whole lifetime of investing; this all-share index thing seems like a nonsense..."

"Simple", says the passive investor. "Firstly, if you use 3 indexes, the index fund provider has to buy and sell within each of them at each quarter rebalance point because some companies will hop across boundaries. That might cost you a small fraction of a percent each year. Admittedly nothing of consequence in the context of the vast performance difference between each of them, but I am short on points so I'm going to make that one."

"Secondly", says the passive investor, "you are never going to be able to deploy your 2.2 trillion pounds into the UK stockmarket by putting a third into the smallcap companies and a third in the midcap companies. There just isn't enough space, the extra demand from you trying to stuff your money into those sectors would mean you would be forced to overpay. You have to put 81% of your £2.2 trillion into the FTSE100 because that is the size of the available market, and then your remaining £400m can go into the other smaller sub-sections of the market.

"Oh", replies the punter - "I don't have £2.2 trillion to deploy. Only £3000. So it seems like your arguments are not so relevant for me, and I probably shouldn't allow the desire to save a few pence of cost be something that causes me to have a more concentrated portfolio or a focus on developed world megacap companies instead of midcap and smallcap companies and emerging markets and so on."

"But But But!" retorts the passive investor, "I have learned about the efficient markets hypothesis and I know that it is not possible to beat the market without taking risk, so anyone who charges you a fee to diverge your portfolio from market proportions is a scoundrel.

The optimum thing to do is to invest cheaply into all parts of the total markets in proportions dictated by the market, which has come up with a standard allocation of capital already based on all information out there. It may not be suitable for your specific needs or objectives, but it is the average of what everyone else is doing, so you cannot be dissatisfied by its results."

"Hmmm...", muses the punter, "you have certainly given me food for thought. I originally presumed that I or my paid advisor or my paid investment manager should come up with a portfolio allocation suited to meeting my performance needs and matching my risk appetite.

But now that you have made your points, even though they seemed flawed, I fear that I will do worse than the average portfolio if I employ someone to select stocks, unless that person takes extra risks. And although I am comfortable with taking risks, there is apparently some extra risk which is defined as 'not doing what the blended average of all investors does'. I should probably just know my place, and fit in, by getting a portfolio representing the average of all financial assets out there in the market with no regard to my own personal objectives. I found the below graph and am just going to invest in those proportions.



Source: McKinsey Global Institute, Haver, BIS, Deutsche Bank estimates, from marketwatch.com

BrockStoker

Are you saying it's a bear market right now bowlhead?

bowlhead99

During the last 6 years, we have had a strong bull market as shown by the performance of the various uk indexes I was mentioning



Are we in a bull or bear market now for the next six years?

Like anyone with any sense, I'm not calling the market, because if I say it is going to do one thing or the other, next, which I cannot know, and then it doesn't happen, people will then call into question the credibility of other comments I make on subjects about which I am qualified to comment.

bigadaj

Herbals going back to your original point, are you sure that the company covers the management costs?

This would be relatively abnormal, the costs might be paid out of the employers contribution, but this would still effectively be money coming out of your overall pot, and so reduce the amount you will end up with when you retire.

mark55man

I would choose an active fund if I was going into frontier markets or otherwise into an investment in an area I knew little about. For Vanilla global equities I would go passive if I could - but as above you r choice to go 100% equities is an active choice I would consider
* property fund
* commodities
* fixed income

My portfolio is
60% Global equities, 20% global property, 20% general commodities

Although the commodities have been flat and seem more correlated with equities than desirable. However if we continue to grow I think they may rebound strongly so am happy with that risk

I do have some FI but that is more for income today than long term so have excluded to align with your situation/ needs