Active Funds or Passive for my ISA investments

MPN

Thanks bowlhead 99, that was a great post and I really appreciate your interesting comments which I think I have understood.

You are quite right regarding my current Isa funds in that they are funds that were either recommended to me or I have researched to have had a good track record.

Regarding a passive funds portfolio and getting the right mix I can try and research this but as you mentioned as I am looking for a suitable IFA for my SIPP I may be best leaving the Isa's to him as well, however at the moment I'm struggling with finding the IFA and knowing if he's OK or not? In the meantime that's why I am looking into my options on a DIY basis so any help or advice would be greatly appreciated.

Linton

MPN wrote: »

Thanks dunstonh

I hold the following active Isa funds, Royal London UK Equity, CF Lindsell Train UK Equity, Liontrust Special Situations (& UK Growth), Fundsmith Equity, Artemis Global Income, Newton Global Income, Jupiter European.

Do you think these will compare favourably to the Vanguard trackers?

The largest factor determining performance probably won't be which particular funds you hold, nor whether they are active or passive, but rather what the portfolio is invested in. Since we don't know what %s you hold of each fund it's difficult to say much. However purely from the geographies it seems that with 3 U.K. , 3 defensive global, and one European fund you may be relatively low in US, EM, and Asia. These areas arguably provide the best chance of growth. In my view the effect would be that you are taking higher risk relative to the likely return than a broader global fund would provide, no matter whether it or your chosen portfolio is active or passive.

The high U.K. Content seems particularly risky to me considering the possible long term effects of Brexit.

Adamjeffs

I did a lot of research into this following a poor start over trading and buying active funds and everything I've read lead me to think trackers are the way to go. As others have said there is no denying some managers will outperform some of the time but they will fade away and others will replace. Timing is everything and who the hell knows which is which

The other thing as well as the headline charges is the so called 'churn rate' which even I who work in the financial sector hadn't appreciated. This is the hidden fees when managers buy and sell shares. The average manager now hold shares for Less than a year! These hidden charges can massively add up. Read John bogles book common sense on mutual funds. Heavy going but totally convinced me

I've got about 18k in the market and split between the 80% and 100% life strategy funds (yes I realise there's duplication there ) seriously considering putting it all in the 100% one due to bonds performance . About 4 k I have bought individual shares to just do short term trades with and have a play but majority of my money goes into trackers. I'm about 20% up over a year . I would expect to be maybe 8% to 10% a year up over thelong term which is fine for me

dunstonh

Read John bogles book common sense on mutual funds.

American. Has all your research been US based? In the US there is clearly more sense to use passives. The UK does not disadvantage managed funds as much. Also, the cost difference between managed and passive in the UK is lower than in the US.

Adamjeffs

Why does it matter whether it's American or not) the principles of investing are the same worldwide. As a headline comparing purely fund charges that's very true but it's the charges you don't see and the amount of churn on the underlying investments that also applies whether it's in the US or anywhere else . The fund charge is just the managers cut not the total cost of investing . That was the real eye opener for me not the headline charge

As I say not saying I'm right but its convinced me hence why if I'm going to actively buy shares I do it myself ( with so far mixed results which why I don't do it very much!)

Adamjeffs

That's also not to say I'm anti advice btw. I'll definitely be seeking an ifa but only when I've got sufficient investments that I need specialist advice . if I ever get that lucky!

bowlhead99

Adamjeffs wrote: »

Why does it matter whether it's American or not) the principles of investing are the same worldwide. As a headline comparing purely fund charges that's very true but it's the charges you don't see and the amount of churn on the underlying investments that also applies whether it's in the US or anywhere else . The fund charge is just the managers cut not the total cost of investing . That was the real eye opener for me not the headline charge

In a US mutual fund, every time they sell a holding for more than they paid for it, income tax is due. In a UK Oeic or UT, tax is not due until you the investor sell your holding of the fund. Hence, the "cost of churn" is higher, relatively, for a US investor than it is for investors from various other parts of the world including the UK. That produces a cost advantage for inactive funds vs active funds, when you are a US investor. That element of the cost of churn does not exist elsewhere in other structures.

As you say, regardless of jurisdiction there are trading costs (like broker commissions) when there is churn. But if the choice is holding onto a terrible share just because it is a large company and the index tells you to; versus flipping it into a better share and incurring a fraction of a percent of fee, then having the flexibility to flip it is not going to create some monster insurmountable cost drag.

John Bogle is obviously a fan of the passive way of doing it which is why his firm Vanguard launched the first retail index fund and it made his name and reputation, as the firm he headed took hundreds of billions of dollars under passive management. He had a vested interest in continuing to promote passives. So he is not an unbiased source, nor a non-US-based investor.

However, if you look at Vanguard's marketing materials for their active funds (they have more of those in US than the UK), they tell people that there are various reasons why their cheapish actives outperform their ultra-cheap passives.

The active vs passive discussion has been done to death here many times before of course.

As I say not saying I'm right but its convinced me hence why if I'm going to actively buy shares I do it myself ( with so far mixed results which why I don't do it very much!)

If you're going to actively buy shares it can make a lot of sense to outsource that decision making to a fund manager, because they have access to a lot more research, can deal for a small fraction of a percent of the trade size, and literally have a team of people monitor the portfolio day in day out for an entire year before and after making any trading decisions.

So, you as an individual - without the research team and limited access to international markets and newsflow and data when doing your own stockpicking - are unlikely to beat that (other than through luck), even if you do work in the financial sector

dunstonh

Why does it matter whether it's American or not) the principles of investing are the same worldwide.

It is important. Most of the passive research comes from America. In America funds, taxation is at source. That is not the case in the UK. Managed funds in the US are effectively handicapped from the start.

So, you have to be careful reading material from the US that promotes passive. There was an article some time back that said that most US managed funds beat passives before tax but most fail to beat passive after tax. We dont have that tax.

There are plenty of good reasons to go passive in some sectors and managed in others. However, if you read a source of info that is not getting basic details right for you country then your research is flawed. There is also the element that people with a bias will publish material to support their bias.

Charges are important. If the margin between managed and passive in one country is 1.4% but in another its 0.6% then that impacts on how many outperform or underperform.

The are some sectors where passives make sense and some sectors where managed make sense. If you don't keep your eyes open and become biased then you stand to potentially handicap your returns.

Also, it is best we have unit trusts and OEICs in this country. Not mutual funds. There are similarities but there are differences.

Adamjeffs

Great posts bowl Head!

No very true you shouldn't buy just based on one source of information and I haven't . I had 6-12 months of doing that (luckily during a period of rising prices so it didn't affect me very much) I hadn't appreciated the difference in underlying charges in the uk so that's really useful but ultimately doesn't change my opinion of why I buy Passives . Of course he has a vested interest and isn't unbiased but doesn't mean he's wrong. You pays your money you takes your choice

Yes that's the reason why I really liked the vanguard group and also that the management company is invested as well rather than the conflict that exists with many of these even with other tracker funds.

And the automatic rebalancing I think for amateurs like me it's a good choice until I build up a bigger pot to play with when I would certainly go for professional advice. The individual shares I own now were ones where I was holding for the long term and where I'd done research and had made a considered choice rather than a punt. Oil company on the basis I expect it to bounce back eventually and healthy dividends in the meantime. Banks as they have legacy issues and brexit will affect for the short term but ultimately a good company . And cyber security company as its a growing trend and with changes in legislation this is going to be a growth sector. Could easily be wrong but rather than doing what I was doing previously and just buying stuff Willy nilly I've made choices for valid reasons and only a couple of k out of an 18k investment That's got to be better!

And financial sector for me is insurance but we have an investment arm and spend a lot of time talking to the advisers there. So definitely not purporting to be an expert just a an enthusiastic and partially educated amateur.

grey_gym_sock

AIUI, US funds are not precisely taxed at source on capital gains; but internal capital gains made by a fund are treated as taxable gains made by the unit holder (and the investor's cost basis for their units is increased by the amount of the gain).

compared to the UK system (in which internal gains made by funds are entirely exempt from CGT, and gains are only taxable when the unit holder sells their units), this is less favourable to actively managed funds - but only in a taxable account. for tax-exempt accounts (i.e. pensions, and (in the UK) ISAs), there is no tax payable on gains in any case.

and in either country, investors should almost invariably start by using tax-exempt accounts, and only go on to a taxable account if they are too rich to fit all their investments in tax-exempt accounts. so this doesn't affect everybody.

i would also observe that there is some (though less) CGT disadvantage from holding an active fund in a taxable account in the UK: the manger may move to another company, or their performance may deteriorate, or whatever ... i.e. you may want to switch funds for whatever reason, and then you may have CGT to pay. a passive fund is much less likely to cease to match the criteria which you used to select it in the first place.

re whether john bogle is biased, and vanguard's active funds:

bogle started out running a company who only had active funds. from what i've read about him, it seems clear that he came to the idea of passive fund management from experience and analysis of the problems faced by active management. after which he launched passive funds. which eventually became big enough that he did have a financial interest in promoting passive funds. though he is no longer running vanguard, so i'm not sure whether he still has any such interest. i suppose you could say that he now has a financial interest in writing books that will sell (but then there are certainly far more books sold promoting active management, or indeed mad trading schemes, than passive management). given his history, my belief is that he is just calling it as he sees it.

AIUI, vanguard's active funds in the US, in addition to having very low management charges (so the premium over passive funds is tiny - unlike the premium for the average active fund in the US), place a strong emphasis on having a low portfolio turnover. this minimizes trading costs. and will also help with the US taxation on capital gains.

overall, there are 3 kinds of cost differences between active and passive management:

1) annual management charges (OCF)
2) internal trading costs
3) tax

and it's only (3) that doesn't apply in the same way in the UK as in the US. but it only applies to taxable accounts, anyway. and there are some smaller CGT issues for active in the UK.

(2) is presumably a bigger effect in the UK than the US. since they have no equivalent to our 0.5% stamp duty.

bowlhead99 wrote: »

if the choice is holding onto a terrible share just because it is a large company and the index tells you to; versus flipping it into a better share and incurring a fraction of a percent of fee ...

well, absolutely. but that only works if you know which is the better share and which is the terrible share - i.e. which will perform better in the future, starting from the current market price, not which has performed better until now. in reality, certainly hardly anybody knows that, and it's not clear that anybody does.