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UK active vs passive: we crunch the numbers

Shares in big companies like Provident Financial have plummeted. As index trackers have to own these, is now the time for active funds?

 
UK active vs passive: we crunch the numbers
 

Provident Financial (PFG) has been anything but that for its owners, including some high-profile funds. Yet that company’s troubles may indeed bring some providence to otherwise beleaguered active managers.

One argument for passive, index-tracking – that markets, especially large company indices, are too efficient to beat – becomes harder to make once FTSE 100 constituents start losing 60% in a single month.

Provident Financial is not alone, either. Carillion (CLLN) and Dixons Carphone (DC) – both members of the elite index until relatively recently – have dropped by more than 20% in a month when the FTSE All Share has been flat.

If dispersion of returns remains high, it will be welcomed by fund marketers – if not always by the fund managers who will inevitably hold some of the duds – who have always tended to argue that such an environment is perfect for active investment strategies.

Those same marketing teams could also point to the performance of active stock pickers over the past year. In the year to July, the average active manager in the UK All Companies sector on an equal-weighted basis delivered positive risk-adjusted returns. The information ratio measure of how much value the managers' decisions generated was an average 0.24, well below the 1 level that is excellent but creditable nonetheless (source: Citywire Discovery).

Over the past three years the average information ratio is still positive, albeit to a much smaller degree at 0.05. Active UK All Companies managers have therefore tended to outperform the index through those timeframes – as well as, course their passive rivals that will lag the index after fees.

Hello Brexit, bye bye UK

Investors seem not to care, however. Active funds in this category have cumulatively shed a net £3.3 billion over the past year. While a large post-Brexit outflow in July last year inflates that number, the sector has suffered net outflows in eight months during the past year.

The exodus may well continue. Some 24% of assets in the sector are with managers who have produced negative risk-adjusted returns over the past year, while those who have underperformed the index on a three-year basis still command a 35% market share.

Not all of the money that has or will be redeemed has switched to passive index-tracking and exchange traded funds (ETFs), though. In fact, according to data provider TrackInsight, more than £5.4 billion has been pulled from ETFs tracking UK equities over the past 12 months.

Evidently plenty of investors – scared off by sterlings’s decline amid Brexit uncertainty –  are simply favouring other markets.

Passive choices

For those sticking with the UK and unconvinced by active managers’ recent performance, there are nevertheless several passive options.

A first choice will be between funds that follow MSCI’s or FTSE’s methodology. The FTSE All Share index has 641 constituents, with an average market value of £3.7 billion and 35% of the index in the top 10. The MSCI UK All Cap index has 36% in its top 10, but is otherwise more geared to smaller stocks with 819 names and an average company size of £2.8 billion.

A second decision will be between open-ended trackers and ETFs, which makes the first a little easier. FTSE is the dominant indexer for the former vehicles, which also tend to be cheaper at present than ETFs.

For example, FTSE All Share trackers are available for 0.06% from both iShares and Fidelity, for 0.07% from HSBC, and for 0.08% from Vanguard. The cheapest All Share ETFs are the Deutsche Bank and SPDR funds, each at 0.20%.

UBS and iShares do run MSCI UK ETFs, but these are again more expensive than the trackers at 0.20% and 0.33% respectively.

For those who nevertheless prefer ETFs as a structure, it may then be wiser to use a FTSE 100 fund instead. The FTSE 100 and All Share have after all exhibited a 0.99 correlation over both long and short-term horizons. iShares has a FTSE 100 ETF that charges 0.07%, and Vanguard and Deutsche Bank both have ones for 0.09%.

For a different approach there is the PowerShares FTSE RAFI UK 100 ETF , charging 0.39%, which weights stocks by their fundamentals. These metrics include sales, cash flow, book value, and dividends. It has returned 21%, to the FTSE 100’s 15%, over the past year.

There is also the UBS MSCI United Kingdom Socially Responsible ETF, which charges 0.28% and employs an ESG screen. It has lagged the FTSE All Share over the past year, by 12% to 15%, having missed much of the rally in mining stocks.

13 comments so far. Why not have your say?

Anthony Tinslay

Sep 05, 2017 at 17:37

Getting on for thirty years ago the FTSE & DOW 30 indexes were almost the same but now they are c7400 & 22,000.The reason is largely due to the fact that the DOW rarely changes whereas the FTSE does regularly and that is why a tracker to the FTSE100 is certainly not a good investment. Tracker funds have to invest in the 100 but must sell when a share drops out and invest when a share joins the FTSE. It follows that a share dropping out has already performed badly and created a probable loss for the tracker whereas a share joining has already performed very well and probably has little further to rise - thus the chance for profit has mostly gone.. All very logical when you think about it.

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hooligan

Sep 05, 2017 at 18:17

so... which active fund managers have a positive information ratio, over rolling and discrete, three and five year periods?

are the active fund manager information ratios before or after fees?

how much risk was taken by successul active fund managers - e.g did managers take 5% risk to get 1% extra return or 10% risk to get 2% extra return?

lastly, would leveraging the passive index to get the same level of total risk as that taken by active fund managers have resulted in higher total nominal returns than that taken by active fund managers? e.g. All Share Index risk = 18% per annum - nominal risk taken by active fund manager = 24%, instead of investing in the active fund manager, simply borrow 33% and buy the index?

the bogey for measuring the success of active management needs to reflect both thte entry and exit fees, running costs AND consistency over rolling and discrete three/five year periods. even then, it is unlikely that the staff responsible for generating excess returns (alpha) and the size of the fund manager have been stable over these periods.

i am watching to see if it is impossible for aberdeen and standard life to perform, simply because the size of funds managed is too big.

do the information ratios calculated have size biases? as in, large managers cannot outperfrom smaller managers - and there is a size threshold where only passive can win?

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Law Man

Sep 05, 2017 at 18:41

"A second decision will be between open-ended trackers and ETFs .... "

I believe ETFs are "open ended: the content of the underlying shares held can rise or fall with new money in or out; in the same way as OEIC funds.

I suspect the author seeks to distinguish "unit trust" style trackers such as Legal & General.

Charges for any form of tracker vary from case to case e.g. Legal & General FT100 unit trust at 0.1% (0.06% with HL) or I-Shares ISF at 0.07%.

Bear in mind that:

(1) with HL you pay an additional 0.45% on the L&G as it is a 'unit trust' but no more for an ETF if your non- OEIC fund holdings already exceed £10,000 (ISA) or £44,444 (SIPP);

(2) you can deal in an ETF in real time at a known price. With the unit trust you have to place an order and learn the price the next day.

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an elder one

Sep 05, 2017 at 19:13

Anthony, none of the footsie indices have moved much compared with the USA lot; mayhap us in the UK stuck in the EU has not helped, EU growth has scarcely sparkled.

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Anthony Tinslay

Sep 05, 2017 at 20:20

Not correct Elder one sorry to say. I mentioned 30 years so please look at following average figures

1987 FTSE 100 - 1713 Dow 30 - 1927

1993 FTSE 100 - 3418 Dow 30 - 3754

2017 FTSE 100- c7400 Dow30 - c22000

I too am "an elder one"

I was just trying to show that investing in a tracker of FTSE 100 is never going to do that well. If you want a tracker then better to use the FTSE 250 which should average out the positions of companies dropping out and joining the 100 index

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hooligan

Sep 05, 2017 at 20:49

andrew, long term is the best lens - hard to believe that the ftse has underperformed the dow as being up "only" doubling v the dow up six times.

sterling has also dropped from around 1.50 usd to 1.30 usd for another 15% or so kicker.

the dow has had as many changes as the FTSE and is the geomtric index of the performance of one share in each of 30 companies - the FTSE is an arirthmetic average of shares in 100 companies - both are price indices nd exclude dividends.

still, irrational exubeance under greenspan was at around 6800 on the dow in 1998.

here's wiki on changes to the dow

https://en.wikipedia.org/wiki/Historical_components_of_the_Dow_Jones_Industrial_Average

eleven out of the 30 dow components have been added since 2000.

https://en.wikipedia.org/wiki/Dow_Jones_Industrial_Average#Components

we will see how the non-industrial companies do

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Franco

Sep 05, 2017 at 22:43

You are comparing apples and pears. The FTSE100 is hardly comparable with the Dow 30. Even if it were so, the result was only to be expected as the American industry, economy and society are much more inventive, risk taking and dynamic.

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hooligan

Sep 05, 2017 at 23:53

franco, the dow is a high turnover index that drops losers and adds winners on an historic basis - it is only "inventive, risk taking and dynamic" because of this.

it behaves more like a fashion industry, whilst the ftse is more like a department store

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an elder one

Sep 06, 2017 at 10:22

Anthony, I don't quarrel with that, I've never indulged in trackers deliberately; I stick to equities specifically, though have some etfs in foreign markets to add diversity. I was simply invoking a brexit point of view that EU membership is counterproductive to some degree

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ndsooty

Sep 09, 2017 at 12:03

You cant compare us and uk indexes. Dividend yields in uk are much bigger than in US - you have to look at total returns

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hooligan

Sep 09, 2017 at 12:19

only from 1900 to 2014, but, ignoring relative risks, adjusting for inflation and ignoring survivorship bias, fx impacts and transaction costs (for rebalancing), there is this little gem taken from the credit suisse global investment returns yearbook of 2014

http://monevator.com/world-stock-markets-data/

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hooligan

Sep 09, 2017 at 12:22

ps. all returns in that link are in us dollare

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Stephen B.

Sep 10, 2017 at 16:25

Going back to the article, what evidence is there that fund managers did in fact avoid Provident Financial and Carillion? My impression is that their problems came as a surprise to more or less everyone, that's why the falls were so catastrophic.

On the indices, as far as I remember the mid-250 index was created in the early 90s at the same value as the FTSE 100, and by the late 90s was about 1000 points behind. Now it's just under 20,000 vs just over 7000, so about a factor 3 outperformance over 20 years. The mega-cap multinationals that dominate the 100 and all-share indices are not at all representative of UK companies generally.

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