Sceptics of active management often point to the fact that the average fund tends to underperform its chosen benchmark, thanks in no small part to the corrosive impact of charges. This has been one of the biggest drivers of the growth in cheaper tracker funds in recent years.
However, contrary to the consensus view, our data shows that active UK funds have posted better numbers en masse in the short-, medium- and long-term.
Over 10 years, for example, the IMA UK All Companies sector – made up predominantly of actively managed funds – has delivered 128.33 per cent. The average tracker with a long enough record has returned 105.32 per cent over this time, putting it a full 23 percentage points behind the average UK growth portfolio.
Most worrying is the margin of underperformance from the worst-performing trackers over the period, many of which contain hundreds of millions and even billions of pounds of investors’ cash.
Performance of passive and active funds over 10yrs
Source: FE Analytics
All data used in the study eliminates survivorship bias, meaning that any funds that may have shut over the period are taken into account in the sector average.
Take the £1.1bn Halifax UK FTSE 100 Index Tracking fund, for example. It has returned just 71.76 per cent over the last decade – almost half as much as the index it is attempting to track.
The fund’s hefty 1 per cent ongoing charges figure has contributed to this underperformance, but it also displays a high tracking error to its benchmark of 7.53 per cent.
The £2.2bn Halifax UK FTSE All Share Index Tracker has returned just 89.57 per cent, which compares with 129.58 per cent from the FTSE All Share.
It also has ongoing charges of 1 per cent, making it only fractionally cheaper than some highly rated actively managed UK funds, such as Fidelity Moneybuilder Growth, which charges 1.2 per cent.
This is not to say that all tracker funds have significantly underperformed. The likes of Scottish Widows UK All Share Tracker and M&G Index Tracker came within 10 percentage points of their benchmark over the 10 years. More recently, low cost Vanguard trackers have operated with very low levels of tracking error.
However, given that the proponents of passives tend to focus on the average actively managed fund, it is only fair that the average tracker is taken into account.
Although the FTSE All Share has actually beaten the UK All Companies sector average over the 10 years, the impact of charges over the long-term ensures that passives will always underperform their chosen index – unless they have a particularly high tracking error which sees them somehow add value to their benchmark.
This, Mark Dampier of Hargreaves Lansdown says, is often forgotten by proponents of trackers.
“You don’t get the market return from trackers, it’s as simple as that,” he said.
FE Trustnet research shows that the average tracker has fallen behind the average actively managed fund by a significant amount over one, three and five years as well, and also underperformed the FTSE All Share and FTSE 100.
Source: FE Analytics
The average FTSE tracker portfolio only included the 25 passive funds that track either the FTSE 100 or the FTSE All Share, with at least a 10-year track record. In total there are 33 passive funds that track either the FTSE 100 and FTSE All Share, and all were taken into consideration when determining which have underperformed the UK All Companies sector average over the various time periods.
Much of the outperformance of active funds over the shorter time frames is as a result of their strong performance over the last year or so.
An FE Trustnet study last year revealed that the poor performance of mega caps that dominate tracker portfolios is the main reason why active fund managers have been able to steam ahead.
However, the trend was evident before last year. The average actively managed UK All Companies fund beat the average FTSE tracker by around 15 percentage points between 2003 and 2013, and was also well ahead over one, three and five years.
Performance of average active fund vs average tracker 2003 to 2013
Source: FE Analytics
One potential flaw of using the UK All Companies sector as a means of comparison is the number of funds with a natural bias towards small and mid caps.
It could be argued that taking this view shows skill on behalf of the manager: active funds are also able to reduce their weighting to the mid caps when they think that sector is due a fall, and our data shows that the mid caps fall harder when markets correct.
Our data also suggests that if you want mid cap exposure, you would be better off with an active fund.
FE data shows that the average UK mid cap fund has returned 264.77 per cent over the last decade, compared with 222.44 per cent from the only FTSE 250 tracker with a long enough track record – HSBC FTSE 250 Index.
Performance of average active fund vs tracker and index over 10yrs
Source: FE Analytics
Using only one tracker by means of comparison is far from ideal, but it is interesting to note that the FTSE 250 index itself has failed to keep up with the average UK mid cap fund. In other words, even a passive fund that managed to track the FTSE 250 perfectly would have underperformed the average actively managed mid cap fund.
The average actively managed fund that focuses on the FTSE 250 also beat the HSBC FTSE 250 index and the FTSE 250 index over one, three and five years.
Over all four time frames, the majority of actively managed funds have beaten HSBC. The trend is most potent over three years, during which time nine of the 10 actively managed mid cap funds returned more than the tracker.
Source: FE Analytics
Gavin Haynes (pictured), managing director of Whitechurch Securities, thinks the obsession with costs has clouded some quarters of the investment community when it comes to discussing the active versus passive debate.
“The obsession with costs means that for some people, this is the only consideration they make, and it’s the sole reason why they go with a tracker,” he explained.
“What they need to understand is that trackers try to emulate the index gross of fees. As soon as fees get involved, you have zero chance of matching a tracker, let alone outperforming.”
He thinks trackers that charge in excess of 1 per cent and underperform by such an extent over the long-term must be avoided.
“It’s quite unbelievable that so many people remain invested in them,” he said. “The problem is that a lot have been sold directly through banks, and the client hasn’t done the proper research.”
“This is especially relevant given that the rise of clean and super clean share classes means that it will be normal for investors to get an actively managed equity fund for an annual charge of 0.75 per cent. This is a very different proposition than pre-RDR,” he finished.
