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Active vs passive for UK equities: we crunch the numbers

Active vs passive for UK equities: we crunch the numbers

Provident Financial 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 investing – that markets, especially large-cap 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 and Dixons Carphone – 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 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 strategies.

Those same marketing teams could also point to the performance of active managers 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 – with an information ratio of 0.24, according to data from Citywire Discovery.

Over the past three years the average information ratio is still positive, albeit to a 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

Fund buyers 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 equivalents, 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 asset allocators – 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 cap 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%.

ETFs will also have to suffice for investors seeking a smart-beta approach to UK equities, although even here there are few options, excluding income funds.

One 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.

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