Summary

Picking a manager is key in actively managed funds as costs matter. Paying a total expense ratio of around 2 per cent when equity returns are 10 per cent effectively wipes out the equity risk premium – essentially a measure of the additional return investors will demand in return for buying equities. Such costs reinforce the need to choose managers who will outperform.

The costs of passive funds are low because the fund is not being "actively managed". But, there is still an element of manager risk and tracking methods vary, ranging from full replication - holding every stock in an index in proportion - to partial replication - holding a sample of the index, in order to reduce dealing costs. Timing of buying and selling can also affect performance.

Choosing the passive route provides peace of mind in that the investor knows in advance they will receive a return approximately in line with the market the fund is tracking, while choosing an actively managed fund will require the investor to monitor the fund’s ongoing performance, and places the emphasis on the manager’s ability to outperform the market. Investors opting for the latter approach should ensure they spend the time and care required to pick the better performing managers.

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