Alan Steel: Passive doesn't pay, whatever trackers say

Investment costs and charges are a big story right now. Google 'fund charges' and there's about 232 million results. Try 'benefits of active management' and there's only four million.

The so-called mathematical facts about trackers don't always add up

So there’s a lot more interest in cutting investment costs than in improving net returns. Indeed, figures from the Investment Association show that private investors have been dumping actively managed funds for “passive” (index tracking) funds in ever increasing numbers over the past few years.

Five years ago, I attended a pensions seminar where an actuary suggested that “because only 25 per cent of active funds can outperform index trackers, pension fund trustees shouldn’t waste their time trying to spot winners”.

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Now let’s for a moment assume that she was accurate. Right now in the UK All Companies sector of unit trusts – so ignoring investment trusts for now – there are 240 funds with at least a five-year record. Adding in UK equity income funds there are another 68, so simple arithmetic says there are 77 funds that are worth finding. Over ten years there are 238 funds, so only 60 worth tracking down. Does that sound difficult to you?

“Evidence-based” experts claim it’s a mathematical fact that you can’t beat a low-cost tracker, ever. But these funds simply mirror an index whether it makes sense or not. When the index falls 50 per cent, a tracker follows. Ouch.

Wise men say “only fools rush in” and that you should buy low and sell high. Index trackers do the opposite, because there’s no thought process. Presumably that’s why they’re so cheap. Or are they? Money Management magazine checked the actual performance of UK index trackers over the past three, five and 10 years and found that the four biggest funds, with £23 billion invested, were consistently way below average. The biggest of them over three years managed to lag behind 209 other funds out of 308 (even after charges).

It gets worse. Advocates of tracker funds keep referring to low costs in their “mathematical facts”, conveniently ignoring that many of those supporters are charging clients a 1 per cent a year management fee plus platform charges of at least 0.35 per cent a year on top. That’s how we recently came across someone who’d actually lost 16 per cent sitting in a cheap “passive strategy” since April 2013.

So the point is this. While I accept there are “active” funds that don’t justify their charges, particularly those that are actually closet trackers but charging full whack for doing sod all, there are many that do justify them. Well managed active funds have been delivering superior returns consistently over the past 30 years.

Don’t take my word for it, check it out. Then you will be in a position to truly judge for yourself.

Alan Steel is chairman of Alan Steel Asset Management