Active vs Passive

Linton

NoviceInvestor1 said:

Fees are the only reliable tool that gives an indication of future performance - lower cost funds perform better than higher cost according to various studies.

It's all well and good saying "x fund delivered y performance after fees" but we know for a fact that there is no such thing as performance persistence in active management. As such keeping costs down seems an important aspect to maximising returns.

If a fund charges 1.5% then to outperform an index then they have to beat that index by 1.5%+ a year just to break even.

If someone is hoping for say 2% p/annum outperformance (seems reasonable for taking on the manager risk of active management, though your mileage may vary) then you'd need the fund to deliver 3.4% more than the index (assuming a passive tracking that index can be bought for 0.10%) to deliver 2% net outperformance. 

That seems wildly optimistic when we know that 90% of funds don't beat the index over the long run (i.e. S&P 500).

Other indexes have different success rates, and some posters may not mind paying big fees for active management to underperform against an index i.e. lower risk is more important than higher returns. Some funds don't have a suitable benchmark too which is worth keeping in mind. 

If at least matching the long term performance of the index is important to you invest in a tracker. The only way of doing better is to take on greater risk

If it is more important to achieve a reliable return determined by one's needs over the medium term then beating the index is irrelevent.

JohnWinder

Interested in this as face a similar dilemma in my work pension choosing between active/passive funds.

These people found fees were quite useful as a guide to past returns. We don’t know how much has changed since then.

https://www.morningstar.co.uk/uk/news/149421/how-fund-fees-are-the-best-predictor-of-returns.aspx

These people summarise their findings about active/passive performances. They suggest the findings are consistent with other research many decades old.

https://www.evidenceinvestor.com/eight-key-takeaways-from-20-years-of-spiva-data/ 

JohnWinder

 If at least matching the long term performance of the index is important to you invest in a tracker. The only way of doing better is to take on greater risk

If it is more important to achieve a reliable return determined by one's needs over the medium term then beating the index is irrelevent.

There’s an index, or several, to track for higher expected returns at more risk. And there are others to track for lower expected returns and less risk. And thus there are a small number of suitable indexes to track jointly to aim for the expected returns you want considering the risk level you’re comfortable with. You’d likely pay less by aiming for ‘your returns’ taking ‘your risk’ with index tracking funds than with active funds, but check the fund specs.

So falling below the returns of a relevant index, or a combination of relevant indexes more commonly, is both unnecessary (in terms of you missing out on easily achievable returns) and will probably cost you more by choosing active funds. But active funds might give you an enhanced return, it’s just that they most often haven’t (and cost more).

noclaf

Thanks Linton/Novice/John for the input on fees.

The vast majority of my pension and non-pension investments are in passive OEIC's and ETF's, I just let them plod along and do their thing. Platform fees capped on my SIPP which is the single largest holding of any of my investments and based on what I would pay for uncapped, it will be a significant saving over the next 15+ years.

For my current work pension, the passive global equity options are all 'responsible' or 'Environmental' something or the other which is slightly limiting.... but there are some active funds for each of the region's and UK Smaller companies so I am using a combo of both active/passive funds but still haven't decided on a final portfolio for this pension....tempted to take a bit more risk and use some racier options as it's currently relatively low in value Vs overall portfolio so conversely my fees will be reasonable till the pot reaches a decent size..hence more open to Active funds if they will help grow my overall pension value.

JohnWinder

Sounds like you’re on top of it. Good luck.

Prism

The Spiva 2022 mid year report has highlighted something for me. It has been the case that GBP denominated UK sector/region funds have generally done pretty well over 10 years. Not the number of funds hitting their benchmark especially - that we somewhere between 50-70% underperforming. But overall average performance was and still is pretty decent.

One way that active fund managers could achieve that performance could be that they are just good stock pickers in a relatively under researched market. However the other way was to work further down the company size scale than the index followed, thereby pushing the risk a bit higher without it being too obvious. 

This year has been a very poor one for those active fund managers and I think it is very much related to the underperformance of UK small caps in relation to the large cap index with its miners, oil companies and banks. YTD over 90% of UK focused funds have underperformed the UK index. At the same time UK small caps are down -22%. I would say those two things are related. UK focused active funds are typically invested in more smaller companies than the index would be, which may explain the long term decent performance.

noclaf

@ Prism

Interestingly, my work pension offers JPM UK Smaller companies, I recall (but could be wrong) it was down around -23% at some point during mid-2022.....the fees are certainly not cheap and it could keep going down into next year but I've been thinking to put in a small allocation e.g: 5-8% as I will be drip feeding every month as part of my contributions + employer match via sal sac. Whilst I ack there could be more pain to come and this is a very volatile sub-section of the market, drip feeding over the next few years seems a reasonable approach and hopefully one day it will come good....unless I am being deluded and just hoping!