Aberdeen: ‘Investors should challenge the assumption passive outperforms active’

The outperformance of investment trusts compared to ETFs over the long term highlights the cyclicality of passive funds, research commissioned by Aberdeen Asset Management suggests.

Investors should challenge the widely held assumption that passive outperforms active, the research paper says, adding that the worst time to buy passive investments is when they have outperformed active funds.

“Passive outperforms active. This has become a widely accepted truth, supported by regulators, by many advisers and, increasingly, by private investors. It has become so widely accepted that it is barely interrogated. Yet research from Fund Consultants calls this assumption into doubt.”

The report argues the logic that passive will always outperform active because of the lower fees doesn’t hold true for investment trusts.

The research by Fund Consultants analysed 500 investment trust ordinary shares and 1,500 ETFs by Morningstar’s global peer groups. The performance of 19 selected sub-sectors was calculated through the weighted average NAV total returns over one, three, five and 10 years.

In the global broad category, investment trusts outperformed overall (11 compared to 4) in all four categories; equity, allocation, fixed income and miscellaneous.

Investment trust equities and allocation funds outperformed in three out of the four periods, all over the medium to longer term. Fixed income investment trusts also outperformed in three of the four categories, but over the shorter and medium terms.

At the sector level, investment trusts outperformed 53 per cent of the time against ETFs over one year, 76 per cent over three and five years and 90 per cent over 10 years. Within 19 subcategories investment trusts outperformed in all categories except one; US equity large cap blend. In the European large cap equity sector active funds returned an average of 96.5 per cent over 10 years compared to 29.3 per cent for passive funds.

The report says: “Investors may be influenced by the shorter-term data. Certainly, the popularity of ETFs can drive performance higher. If advisers are encouraging people to invest in index products and money is directed towards the sector, it means a lot of money is pushed into those companies that make up the highest weightings in the major indices. As such, it can be self-fulfilling.

“However, it also suggests that performance will be cyclical. Passive will have its moment when large caps or certain sectors outperform, but it may be temporary. It also suggests that the worst time to buy passive funds is when everyone is talking about the outperformance of passive.”

Fund Consultants suggests the costs associated with active funds are “a red herring”, arguing that it’s the “absolute profit that counts, not the magnitude of the expenses”.

“We believe that the lower total expense argument for passively managed funds should be finally put to bed as its takes no account whatsoever of the associated returns. And for that matter all returns, be they in investment trusts or ETFs, are quoted net of expenses, so are therefore already factored in, and are what investors should be focused on.”