Many investors in the know are keen on passive funds rather than active funds.
What are active funds?
Investment funds that are actively managed by a fund manager or fund management team. The assets inside the fund e.g. shares are traded i.e. bough and sold everyday as markets, economies, trade sector news and sentiment vary.
What are passive funds?
They are not actively managed, they are usually a ‘mirror’ of some form of stock market, bond market or other sector e.g. technology, pharmaceutical area. In the case of stock market indices such as FTSE 100 or S&P 500 in the USA, a passive fund would be a FTSE 100 Tracker i.e. it simply mirrors the stock holdings of the FTSE and tracks it. Other sectors like technology you may have an Exchange Traded Fund (ETF) which tracks/mirrors the stocks listed in a technology sector.
Index trackers and ETFs generally have very low management charges of say 0.2% pa and that is their attraction. You get exposure to a particular market or sector with low charges as there is no active management only mirroring and tracking.
Actively managed funds tend to have fund management charges of 0.40% to 0.75% pa and can be higher for focused funds e.g. ethical/green funds, UK smaller company funds etc.
There is no doubting the attraction of simply investing across a range of trackers to get a balanced portfolio and benefitting from low charges. That said, when we do our own research on the most consistent active funds they generally do beat passives for performance. Many do not but many do – you need to look for consistency in active funds.
Why would consistent active funds beat passive funds?
They are pro-active. A fund manager may have been taking some defensive both before and during the coronavirus market volatility period whereas a passive fund would simply have tracked the falls and rises.
That said, there comes a point where charges do have greater impact. E.g. On £1m investment = For passive funds say £2,000 pa (0.2%pa) in charges and for an active fund say 0.6% pa = £6,000pa in charges. That’s significant.
But when compared to having £100k invested, that’s £200pa in charges on passives and £600pa on actives and provided you do your fund research on consistency, many active funds outperform passives and could make up that £400 difference.
We believe a portfolio should have the right balance of active funds and as the fund grows, a greater bias towards passive funds.