Why active funds are good for the economy and good for investors
In his Little Book of Common Sense Investing, John C Bogle said that “attempting to beat the market is a loser’s game”. We disagree with the late founder of Vanguard Administration. We expect many UK investors would, too. That’s because his proclamation doesn’t tie-in with their own experiences over the past decade.
It’s the weight of money that counts, not the number of funds
Let’s examine some of the evidence around the ability of active managers to beat the market. Take the global sector over 10 years for example. There are 172 actively managed funds with a track record over this time period with combined assets under management (AUM) of around £156 billion. Over the past ten years, 73 (42.4%) of these funds have outperformed the MSCI AC World Index. On closer inspection, however, these 73 funds manage £110 billion – or 70.5% of the total invested in the sector. By this measure, active managers have handsomely outperformed.
The pattern is similar across all the major sectors. Indeed, in the UK All Companies, Europe ex UK, North America and Japan Investment Association sectors, active money-weighted performance was better than in the global group. In Europe ex UK, a whopping 87.5% of the actively managed asset outperformed the MSCI Europe ex-UK index for example. The trend is in evidence across periods shorter than ten years, too1.
We think it’s fair to say that across all geographic sectors, money tends to gravitate towards the best-performing funds. This is what should happen when wealth managers and financial advisers are doing their jobs. The UK Smaller Companies sector gives us a stark example of this trend. There, 37 of 44 funds that have existed for the past decade have outperformed the Numis Smaller Companies (excluding Investment Companies) Index. These 37 funds account for 93.5% of the sector’s AUM.
Are there too many active funds?
What is true is that many sectors contain far too many funds. Many will be under-performing, or taking in little money. Asset management companies often keep funds open longer than they should due to the expense and hassle of closing them down. The good news is that, as we mentioned above, the flows tend to go to those funds that are producing better returns. When passive managers criticise their active counterparts, they tend to talk only of the number of funds in a given sector that are underperforming. We haven’t often seen them explain whether these numbers are significant in terms of the amount of money invested in the sector.
Good for businesses?
For many businesses, Covid-19 has been a scary experience. Many companies in industries such as aviation, travel, leisure and hospitality have had to close down for months at a time. Of course, the closures have placed great strain on these firms’ workforces and their balance sheets. When they needed new equity capital to tide them over, active managers stepped up to the plate. Easyjet, Ryanair and Jet2 were among the 26 UK-listed travel & leisure companies that have had to raise money so far during Covid. 16 building and construction businesses have also tapped the market.
By 15 November UK companies had raised a total of £19.4 billion, and £ 3.1 billion of this was on the growth-oriented Alternative Investment Market (AIM) (Numis Securities). Most of it came from placings. The vast majority of the money came from active managers. Where were the passive managers? Well, participation in placings can be challenging for their trading algorithms. They also tend not to participate in new issues before companies join indices. Allocation of capital is not really their bag. A passive manager once said that they wanted “to do what the market decides”. As passives gain market share, that “market” is becoming smaller and smaller.
Good for the planet?
This brings us on to the subject of environmental, social and governance (ESG) matters. Active managers have been building ESG into their investment processes and engaging with companies for some years now. Representing the owners of the investee businesses as they do means that they must exert their influence on ESG issues. Passive managers, on the other hand, own whole indices. This means their portfolio can contain shares in thousands of companies, based all around the world. Engaging with them all individually would be incredibly time-consuming. Lucian Bebchuk of the Harvard Law School suggests that index funds are “excessively deferential” to corporate management, even when this conflicts with investors’ needs or harms corporate performance. Yes, passive managers can vote on resolutions, but they can’t take the ultimate sanction. They can’t just decide to sell the shares.
In our view, active funds are the bedrock of stock markets. Rather than building in underperformance, active managers are showing that attempting to beat the market is a winner’s game.
FE Analytics, performance as at 31 October 2020, primary share classes used, passive index tracker funds excluded, total return net of fees, GBP