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Why I’ve just bought my first passive fund… and why it won’t be the last

30 October 2014

My portfolio has always been with active managers but after I spent more time thinking about the outcomes these investments are supposed to achieve, I bought my first ever passive.

By Gary Jackson,

News Editor, FE Trustnet

Until now my personal investments have all been in active managers, but I’ve recently started buying a passive fund for my ISA for the first time and think there will be more moves in this direction over the months ahead.

The argument about the merits of active versus passive investing could go on until the end of time with neither camp willing to give ground.

Personally, I’m a staunch advocate of active funds. While everyone concedes an active fund will find it impossible to outperform in every kind of market, I believe investing with the right manager is the best strategy over the long term – despite the higher charges that come with it.

I like stock pickers – the managers who are willing to do the legwork of finding the compelling individual opportunities in the market then take a big bet that these companies will beat the average stock over the long term.

But does that mean I should ignore the vast swathes of the market left behind by these picky investors?

In my portfolio at the moment are the likes of Martin Cholwill's Royal London UK Equity Income fund, Andrew Rose’s Schroder Tokyo fund and James Thomson’s Rathbone Global Opportunities fund, of all whom are known for their bottom-up styles. I added these as I wanted more than just market gains, and I’m happy to say all have performed strongly in recent years.

I reviewed my asset allocation last month, and started drafting a list of the areas I wanted to get more exposure to, mainly via global funds. I suddenly realised I was committing one of the fundamental investment mistakes – I was collecting funds rather than adding them to do a specific job.

Thankfully my moment of clarity was well-timed, allowing me to amend the process behind my asset allocation. Like most people I take a list of asset classes then consider how compelling each is and work out how much to allocate to each area; what I should be doing is thinking about the outcomes I want from my investments and allocating according to that.

Why do I want to increase my global allocation? Not because I want more exposure to Spanish banks or Brazilian industrials, but simply because I want to increase my market participation. And to get that, I don’t need find an active stock picker who invests in a tiny part of index - what I need is a fund that gives me broad exposure.

That’s how I came to add the Vanguard LifeStrategy 100% Equity fund to my ISA. It is a globally diversified portfolio of equities, built using Vanguard’s range of low-cost trackers. Its largest geographical allocation is the US at 43.1 per cent, followed by the UK at 25 per cent, Europe ex UK at 13.5 per cent and emerging markets at 7.4 per cent.

Performance of fund versus index and sector since launch

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Source: FE Analytics

Importantly, it has clean ongoing charges of just 0.24 per cent, making it vastly cheaper than the average active fund out there. This will help to minimise the erosion of my gains over the long term.

It’s hard to find a consistent performer in the IMA Global sector but this fund seems to stack up well. As a recent FE Trustnet study showed, more than 80 per cent of the sector’s members have failed to beat the MSCI World index over three years.

Being a collection of trackers, I’m not expecting Vanguard LifeStrategy 100% Equity to beat the market; however, it caught my eye because of how it looks when compared with the rest of the peer group.

The fund sits in the IMA Global sector’s second quartile over one and three years, as well as over three and six months. Since its launch in June 2011, it has returned 32.94 per cent – less than the 39.47 per cent gain in the MSCI World, but well ahead of the 24.84 per cent return made by the average fund in the sector.

It also compares well on other metrics. The annualised volatility over three years is 11.46 per cent, which is higher than the peer group’s 10.88 per cent and exactly the same as the MSCI World’s.

Meanwhile, its maximum drawdown, which shows what would have happened if an investor bought at the peak and sold at the trough, is 10.65 per cent. This is just higher than the sector’s 9.98 per cent and the index’s 10.14 per cent.

And a final reason behind my decision was that it sits well alongside the Rathbone Global Opportunities fund.

Performance of fund versus index and sector over 3yrs

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Source: FE Analytics

FE Alpha Manager Thomson runs a concentrated portfolio with a bias towards high-growth business and mid-caps. In searching for “undiscovered growth stories”, the manager looks for innovative companies that consistently beat expectations, have the potential to outclass their competitors and operate in a rapidly growing market.

The fund is highly regarded and is included in FE Research’s Select 100 list of preferred funds. The team suggests it could be a good option for investors looking for aggressive capital growth.

They said: “The fund’s performance depends solely on the manager’s ability to identify and invest in companies with the potential for growth.”

“The portfolio construction has evolved over time: Thomson’s approach was too aggressive before 2008 and the fund performed poorly in that year. The manager appears to have learned from his mistakes, however, and is now quick to identify and drop a position to avoid further losses when it isn’t working. He also keeps clear of areas where he has been unsuccessful in the past and sticks to where he has proved he can make money.”

While I remain happy with Rathbone Global Opportunities and want to keep it in my portfolio, I’m conscious that it isn’t a core global fund. The manager is very pro the US and has next to nothing in emerging markets. He is also underweight Europe, with just an 11 per cent position at present.

For this reason, I’m going for a paired approach, using the Vanguard vehicle to get broad market exposure, and the Rathbone portfolio as a satellite holding. I’ll be drip feeding into Vanguard LifeStrategy 100% Equity every month, and eventually envisage it making up half of my global equity exposure.

As I say, I am a committed user of active funds - but I don’t think this will be the last time I make use of passives.

For example, as I’m in the process of transferring over my pension there’s a strong chance I’ll be adopting a core/satellite approach there as well - using several trackers at the heart of the portfolio alongside a good quality multimanager fund.

The plan now is to reassess everything in my ISA to see how it fits my investment outcome plan. I can see this meaning a greater use of trackers to fill up that market participation bucket - but when it comes to other areas such as alpha generation and downside protection, there will still be a focus on truly active managers.

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