Less than a tenth of wealth management clients’ assets are invested in cheaper passive funds, despite widespread criticism of active stockpickers by academics and regulators over high fees and bad performance.
Active funds, where portfolio managers select investments rather than follow an index, have come under intense scrutiny in recent years on the back of damning research that found that the majority fail to beat their benchmark.
More than half of wealth managers in the UK say they have increased the use of cheap passive funds, but they still remain a tiny part of client portfolios, according to figures from Wealth-X, the research provider.
Just 9 per cent of assets in portfolios run by UK wealth managers, on average, were invested in passive funds, which track an index rather than try to actively pick the best-performing stocks. More than a quarter of 36 British wealth managers polled said zero per cent of their clients’ portfolios were invested in passive funds.
Amin Rajan, chief executive of Create Research, the investment industry consultancy, says wealth managers have been slow to embrace passive funds over concerns that these strategies could suffer in difficult markets.
“Passives are cheap, but not cheerful, as most wealth managers recognise,” he says. “However, if active funds continue to underperform, wealth managers will be forced to increase their allocations to passives in order to attract and retain assets.”
Last year, research by S&P Dow Jones, the index provider, found that almost all US, global and emerging market funds had failed to outperform the market since 2006. Regulators in Europe also found that many active funds were charging high fees despite closely following their benchmark, a practice known as closet tracking.
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Matt Philips, managing director at Thomas Miller Wealth Management, a UK company that oversees £3bn for its investors, says he has been advising clients to use passive funds for many years over concerns about active fund managers’ performance.
“The underperformance of active funds is a consequence of too many managers masquerading as active when then are really index ‘huggers’ and doing it at an expense, which is not justified by the outcomes and performance,” he says. “In these circumstances we’d buy a passive strategy. We avoid these funds completely.”
Lynn Hutchinson, senior analyst at Charles Stanley, says the wealth manager has turned to passive funds — including exchange traded funds (ETFs) and index trackers — in recent years in a bid to find cheaper ways of accessing markets.
She says: “The bottom line is that you can’t rely on a brand name or a past record to be sure of outperformance from an active fund manager.”
Rising concerns about active funds have contributed to the rapid growth of the passive management industry. Figures from Morningstar, the data provider, show that funds invested into passive funds globally grew 4.5 times faster than those under active management in 2016.
In the UK, assets managed in passive funds grew by more than 24 per cent between the end of 2015 and April 2017, while active fund assets increased by just 3 per cent.
However, strong demand for passive funds has also sparked concerns. Mick Gilligan, head of fund research at Killik & Co, the wealth manager, says that as more money is raised passively, there is a risk that markets could become less efficient.
There are also fears that passive funds are fuelling an unsustainable price bubble in the US stock market.
According to Wealth-X, few wealth managers have decreased their overall allocation to passive funds over the past five years. But Thomas Miller’s Mr Philips says the wealth manager has recently begun switching back to active funds.
“We have been trimming our passive exposure back as we believe there are defensive qualities in certain sectors of active management that will prove useful at this point in the cycle,” says Mr Philips.
Chris Ralph, chief investment officer at St James’s Place, the UK wealth manager, adds that there are legitimate concerns about what would happen to investors in passive funds if there was a market correction.
“If we experience market volatility, we are in untested markets,” he says. “The counterpart to that is for our active fund managers, who are buying shares because they think they are good value. All of this creates opportunity.”
But Andrew Summers, head of fund research at Investec Wealth & Investment, plays down such concerns. “Market volatility alone is unlikely to create an inflection point. Indeed, it is not assured that the average active manager will do better if market volatility increases.”