Ricketts (pictured), who runs a variety of funds of funds at Margetts, says there are signs that stocks are becoming less correlated as financial markets begin to normalise. In such an environment, the manager warns that passives do not offer investors any degree of protection, which is why he now prefers actively managed portfolios which can sieve through the index for opportunities and avoid the potential problem areas.
"Recent data from UBS showed that the correlation of stocks is dropping," he explained. "Obviously, when there is a strong correlation then passive funds are a good place to be."
"Since March 2009, markets have been very correlated and we have felt that having passive exposure has been the right thing to do – in the past we have very much been on the tracker curve."
"What we have seen recently is that politicians and officials have driven the market; I mean Ben Bernanke can add or take away 10 per cent with whatever he says," Ricketts explained.
"Eventually, however, it has to come back to a company’s profitability, cash-flow and future growth."
Ricketts says that there have been many instances in the past when active funds have been able to protect their investors' capital more effectively and he believes that will be the case for the foreseeable future.
"What the credit crunch showed us was that banks had led the market and comprised a huge part of the index," he explained.
"However, though a lot of active managers didn’t see this, those who saw the banks were massively overleveraged and avoided them fared much better than those who followed the index."
"Unfortunately for us fund managers it can be just a feeling. However, although it is in its early stages, I feel that active funds are now the best bet," he added.
FE Analytics data suggests this trend may have already started: the average UK All Companies and UK Equity Income funds have been significantly less volatile than the average UK tracker over the past year and coped much better with the market sell-off in May and June.
FE Trustnet will publish this data in an article later on today.
Ricketts believes the risk of passive funds is particularly high at the moment as they have unwittingly fuelled a speculative bubble in recent years, making the largest members of various indices more and more expensive.
Such a risk, he explains, can only be avoided by an active manager.
"In terms of a current bubble, I don’t think there is anything specific; however, since the crash there are a lot of companies that have cut costs and deleveraged – basically looking a lot fitter – but haven’t been rewarded with shareholders," he explained.
"On the other hand, there are companies that aren’t seeing any real profit growth but are still seeing huge amounts of investor capital."
He says one of the best examples of trackers adding to a bubble was with Vodafone during the dotcom bubble.
"What seemed to happen in the late 1990s was that Vodafone continued to get bigger and bigger," he explained.
"As it was a tech stock, people wanted to hold it, which made it a larger part of the index. However, as it became a larger part of the index, trackers began to buy it more and more, which made it even larger."
"At one stage it got to 14 per cent of the index and the FSA had to change its legislation because it had been the case that the maximum amount a fund could hold in a single stock was 10 per cent."
"Yes, its size relative to the index was driven by the tech bubble, however tracker funds were also unwittingly making the bubble even bigger," he added.
As the graph below shows, Vodafone’s share price rocketed and subsequently fell off a cliff at the start of the 21st Century.
Performance of stock since Jan 1995
Source: FE Analytics
If an investor bought £10,000 worth of shares in the company in January 2000, three years later they would have lost more than £6,200. Those who bought shares in Vodafone in March 2000 still would not have made their money back.
Ricketts has been managing funds of funds in the IMA universe for nearly 20 years.
According to FE Analytics, his £84m Margetts Venture Strategy fund – which he took over in 1995 – has been the second-best performing portfolio in the IMA Flexible Investment sector over 10 years with returns of 192.42 per cent.
Performance of fund vs sector over 10yrs
Source: FE Analytics
In recent months, Ricketts has added active exposure at the expense of passives across his portfolios. In the US, he is now backing the £48.3m BNY Mellon American fund, for example.
"We have started to increase our allocation to US active funds over passive funds," he said.
"One of the funds we are looking at is BNY Mellon American. It doesn’t move too far away from the index, which we feel is a good transition from a tracker fund."
"It holds just 70 to 80 stocks and though it follows the same sector weightings, it certainly doesn’t track the index. The fund’s performance in the past has been in-between, not great but not terrible," he added.
The BNY Mellon American fund was launched back in 1986 and has struggled to beat its benchmark – the Russell 1000 Growth index – and the IMA North America sector over the medium- and long-term.
However, Elizabeth Slover took charge of the fund last year and the performance has picked up. Our data shows it has beaten is benchmark over one year; however, it has still lagged the sector average.
Performance of fund vs sector and index over 1yr
Source: FE Analytics
The BNY Mellon fund has an ongoing charges figure (OCF) of 1.68 per cent and requires a minimum investment of £1,000.
