Active Funds or Passive for my ISA investments

Adamjeffs

I can potentially see a need for active management in niche sectors where expertise can be useful though . Again whether that outweighs the extra costs is a different matter.

dunstonh

Adamjeffs wrote: »

I can potentially see a need for active management in niche sectors where expertise can be useful though . Again whether that outweighs the extra costs is a different matter.

As i said, in the UK, the cost difference is very low now. In the US it is higher (where we used to be some years ago). If a managed fund happens to meet an objective better than a passive fund in that particular area, then it seems daft to be worrying about a figure of around 0.5% a year when the differences in return could be a lot more.

Where you invest is a higher priority than charges which are a secondary concern to that. Charges should not by the primary concern.

bigadaj

dunstonh wrote: »

As i said, in the UK, the cost difference is very low now. In the US it is higher (where we used to be some years ago). If a managed fund happens to meet an objective better than a passive fund in that particular area, then it seems daft to be worrying about a figure of around 0.5% a year when the differences in return could be a lot more.

Where you invest is a higher priority than charges which are a secondary concern to that. Charges should not by the primary concern.

The costs difference isn't very low though. It is actually many multiples, even if we look at say lifestrategy with the spread and rebalancing included, rather than a traditional tracker, then the managed fund is still three times the cost, and 0.5% additional fee which is approaching 10% of the average investment growth.

Unless of course you can confidently predict both the managers that outperform and the correct sectors to be in as well.

dunstonh

Unless of course you can confidently predict both the managers that outperform and the correct sectors to be in as well.

You dont have to predict. You make a judgement call based on the investment strategy. Do you feel that that xyz fund offers better potential than abc fund. If yes, then go with it. if not, then you dont. If you feel you want a general UK growth fund, then go with a tracker. managed funds tend to offer little in that area. If you want an equity income fund (or an ex equity income fund that no longer fits that classification) then you are more likely to pay more for a managed fund. If you want value then you are likely to go managed. Managed funds do require you to be more in control of your portfolio. You are not going to want to stay invested in a value fund for a whole economic cycle. Whereas a tracker, you would.

grey_gym_sock

dunstonh wrote: »

As i said, in the UK, the cost difference is very low now.

but that's just the OCF. which is only 1 of the 3 areas where costs vary:

grey_gym_sock wrote: »

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

how much higher is (2) for active funds? is this information even available?

and isn't part of (2) a disguised form of (1)? i.e. aren't fund managers allowed to pay inflated dealing commissions, in return for which they get kickbacks (in the form of research or data feed or whatever - i.e. things which they use for managing the fund, but which naive/honest people would expect them to be paying for out of the explicit AMC)?

in which case, focusing on (1) in isolation is very misleading.

dunstonh wrote: »

You make a judgement call based on the investment strategy. Do you feel that that xyz fund offers better potential than abc fund. If yes, then go with it. if not, then you dont. If you feel you want a general UK growth fund, then go with a tracker. managed funds tend to offer little in that area. If you want an equity income fund (or an ex equity income fund that no longer fits that classification) then you are more likely to pay more for a managed fund. If you want value then you are likely to go managed. Managed funds do require you to be more in control of your portfolio.

i do agree that with the idea of starting with investment strategy, and then seeing what funds are the best way to implement it.

and there are some areas where there are currently few passive products available, e.g. value.

You are not going to want to stay invested in a value fund for a whole economic cycle. Whereas a tracker, you would.

i'm surprised by the suggestion that you wouldn't stay invested in value over a whole cycle. the academic research into the "value factor" suggests that it is expected to outperform in the long term, but that there are quite long periods when it will underperform. which suggests you should ideally be invested in it for several cycles, to increase the probability that you will actually see any outperformance. are you advocating market timing?

jamesd

dunstonh wrote: »

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.

Just to expand on that a bit:

1. The US has a higher capital gains tax rate for holdings of less than a year. They are taxed as ordinary taxable income, so from 10% to 39.6% depending on top tax bracket you have. A person on $37.650 to $91,150 income would pay 25% income tax on short term capital gains but 15% on long term. So the things active funds to to increase returns have reduced benefit, potentially hurt very badly by a 10% higher CGT rate. Also hurts passives when they switch from net investing to net paying out.

2. All trades by a fund are reportable each year on an individual's tax return. So you don't get compound growth before CGT, you're charged that 15% or 25% each tax year.

3. And of course lower tax free allowances. The US also has fewer tax wrappers with lower limits than the UK.

What this tends to do is:

A. favour buy and hold strategies in the US, since that's the way to reduce the annual tax bills and allow before tax compouonding.
B. favour ETFs which in the US are structured in a way which reduces the tax effect.

So it's not only active v passive it's also ETF or not and buy and hold strategies that are influenced by US-specific rules.