The average active UK growth fund has beaten every single FTSE 100 or FTSE All Share tracker fund in 2015 as well as over one, three, five and 10 years, according to research by FE Trustnet
Passives/tracker funds, aim to replicate the movements of an index such as the FTSE All Share as closely as possible while active funds aim to beat it by a mixture of qualitative and quantitative research analysis and human judgement.
The former has seen a huge upswing in demand in recent years thanks to a price war between the biggest passive providers sending costs down, ultra-low interest rates and easy monetary policy buoying stock markets and decreasing correlation of index components as well as some more general doubts of the value of more expensive active strategies.
However, our data suggests investors would have been more rewarded being invested in the average fund in the IA UK All Companies sector over the past decade as well as over the medium and shorter time frames. In particular 2015 has been a shocking time for FTSE 100 and All Share passives.
Every tracker fund in the IA UK All Companies sector underperformed the sector average return as well a portfolio of consisting just active funds. The majority of the 25 tracker funds aiming to replicate the FTSE 100 or FTSE All Share were bottom quartile in 2015 with the rest in the third quartile.
Looking more deeply within in the sector and contrasting a portfolio of the average active funds as well as the average tracker fund the trend is again demonstrated. According to FE Analytics, the average UK growth fund has returned 7.99 per cent while the average FTSE All Share tracker has returned 6.54 per cent. The FTSE All Share has gained 6.81 per cent this year.
Performance of average active portfolio versus average passive portfolio in 2015
Source: FE Analytics
Mike Deverell, investment manager at Equilibrium uses both active and passive UK growth funds to build portfolios and says over the longer term the trend is for the average active fund is only likely beat a passive fund marginally at best.
“Over the long term we have found that the average UK fund and the FTSE are pretty similar. There is not a lot to choose between them over the really long term. But you do get periods where active does better and passive does better. So, we use both but we do tend to change the weightings depending on what where we think market conditions are at,” he said.
Indeed, he says he has been scaling back passive exposure across portfolios recently due to an expectation that they will underperform for some time.
“Recently we have been very light on FTSE trackers partly because we thought there is a lot more value in smaller stocks than large caps - the big mega caps really haven't gone anywhere.”
“Over the past two or three years if you look at every part of the UK market, the FTSE 250 and Small Cap parts have done way, way better than the FTSE 100. There are a few times when the FTSE 100 has done a bit better.”
As the graph below shows mid and small caps have not only been better performing than large caps for 2015 so far, but in recent period of market weakness, they have fallen less dramatically than the FTSE 100.
Performance of indices in 2015
Source: FE Analytics
However, over the longer term the performance of the average tracker versus the average active fund is also clear. Over one, three, five and ten years the average active fund has beaten the all of these tracker funds.
It must be noted that the composite portfolios we have made have survivorship bias as they only include funds which exist today. However, the portfolio of active funds’ returns are almost identical to those of the IA sector average (which doesn’t have survivorship bias and is beating the All Share over all the time frames we have mentioned).
Source: FE Analytics
While the FTSE All Share has nearly kept up with the UK All Companies sector average over 10 years, it is two percentage points behind, the impact of charges over the long-term ensures that passives will always underperform their chosen index unless through error they add value to their benchmark.
Deverell says the more recent underperformance is partly secular and partly cyclical in nature due to currency movements as well as the underperformance of key companies.
“The largest companies in the FTSE 100 are Shell and BP which together make up about 15 per cent. So there has been an obvious drag - the oil price weakness. The likes of HSBC have also had problems. If you look at what the top 10 largest constituents are, and they really drive not just the FTSE 100 but also the FTSE All Share that tells you why trackers have been underperforming.”
“Over the long term an actively managed fund ought to outperform the index because they can clearly put more in mid and small cap companies and over the long term they have been shown to outperform. However, a lot of them don’t really do that and stick very close to the index.
He says the other thing that driven under performance of trackers has been the strong pound, which has held back the earnings of large caps.
Performance of pound/dollar over 1yr
Source: FE Analytics
“Currency has big influence on the FTSE 100 and so if currencies are moving strongly in one direction then it can make big difference positive or negative on those earnings and the share price. Further down the cap scale it has had less effect because they are more domestically focused.”
“Versus the dollar that has really come off in 2015 because you have a lag on earnings you'd think it would help those companies that make a lot of the money in the US but the opposite is true in Europe.”