RDR spices up debate over active v. passive

FS Adam Lewis 160 byline

It has been a while since my last active versus passive funds leader column, so research published last week by Vanguard proved timely to reopen the debate.

Not surprisingly the issue of costs is again the main battle ground. In the run up to the now imminent RDR deadline, the subject of costs and their impact on funds has been one of the main subjects of 2012.

With the research coming from a mainly passive funds provider you are hardly going to fall off your chair when their latest research into the impact on active performance supports the case for the former, but the numbers are interesting nonetheless.

According to Vanguard’s Case for Indexing research, only 17 per cent of active equity funds and 4 per cent of active fixed income funds that were in existence in 1997 have outperformed their prospectus benchmark over the subsequent 15 years., while similar underpeformance was shown over five and 10 year periods. Vanguard points out the costs of commissions, management fees, bid-ask spreads, admin and where applicable taxes – all combine to reduce realised returns over time.

To those new to the debate the depth of the underperformance may seem startling. However is not a new argument and has been re-hashed a lot this year as the active management industry has faced sections of criticism for them to be more transparent with their fee structure, to show these “hidden costs”. One of the direct consequences of the RDR has been a wave of clean share classes launched over the past 12 monthsin which the annual management charges drop to 0.75 per cent, which could make a significant change to performance.

However even then there will be a significant portion of active funds that underperform, as even those who are there biggest users will testify to, the majority do underperform over long period of time. The hope is identifying those which can buck the trend, and maybe more importantly understanding that it does not have to be the case of one versus the other. There is room for both.

Even Vanguard admits that not all passive funds are created equal so they will not all perform the same. They also admit there will be times when they under perform active strategies. So of course while costs are important, they should be the defining element of why you choose to invest.