The results of a recent poll on the New Model Adviser® website suggest the majority of financial advisers still invest predominantly in active funds.
The active preference is a surprising outcome given the rise in popularity of passive funds over the past few years, as advisers became wary of the effect of client charges, and the recent criticism from the regulator of active fund performance.
The poll asked: how are your portfolios weighted to active and passive funds? 28% of respondents said 100% active, while 42% said over 50% active (see bar chart below). This is a striking result, but advisers we spoke to see historic reasons for this active dominance.
‘The majority of IFAs will have an active bias due to legacy business,’ said Joel Barrett, wealth manager at Bishop’s Stortford-based Barretts Financial Solutions, which has an 85% active bias and 15% passive.
‘Exchange-traded funds have been around for some time, along with other passives. But using Vanguard [Asset Management] and Dimensional [Fund Advisors] has come to the fore in the past five to 10 years.’
Robert Forbes, director of London-based Stadden Forbes Wealth Management, which is 85% passive, said. ‘If we went back 10 years, 100% would be almost totally active.’
It looks likely the proportion of passive funds under advice will continue to increase. But Mike McGurrell, director at Sunderland-based Grainger Financial Planning, which is around 70% passive, said active management holds attractions for many clients. He said despite clients being advised, investment decisions are influenced by their own preferences.
‘When you explain an asset allocation populated by tracker funds, it’s not an exciting proposition for many clients,’ said McGurrell. ‘But when you explain what fund managers do to shop around for value to gain outperformance, that’s something they can relate to.’
Advisers believe an active approach works best in some sectors. ‘In the UK smaller companies space, active offers value,’ said Forbes.
However, Barrett said: ‘A tracking fund in UK smaller companies doesn’t track the index tightly enough for us to be happy. You’ll see better active performance from global emerging markets funds.’
McGurrell said more sophisticated clients favour passive. ‘Some clients are well read and have a greater understanding,’ he said. ‘These clients are more inclined towards a passive approach.’
Despite his firm’s active preference, Barrett said: ‘Looking at UK stocks over the past year, you’ve got to accept events happened that hurt active managers.
‘Some underperformed by investing in financials, which were cheap prior to the Brexit vote. But Brexit brought them down by another 30%, so funds holding these could have underperformed passive.’
He pointed out passives had performed better than active on US-based large cap equity funds and there is scope for a rise in bond passives. ‘Returns on bonds will be thin over the coming years due to global monetary tightening,’ said Barrett.
‘You might see a focus on passive bond funds to reduce the cost burden on potential returns.’
He does see scope for active outperformance. ‘If you find a good active manager, you do notice the performance is better. Not just above fees, but with an additional return on top.’
Even passive exponent Forbes sees a place for active. ‘Not all low-cost tracking funds fit the bill and not all active funds are poor value for money. Overall, it’s a case of horses for courses.’