It is nonsensical to engage in an active versus passive debate when both investment vehicles should sit alongside each other in a portfolio, according to John Husselbee. 
The manager, who is head of multi-asset at Liontrust, runs a discretionary model portfolio service consisting of 10 risk-based strategies that he puts together via a blend of active and passive funds. Typically, the manager aims for the cost of putting the underlying fund together to remain at around 75 basis points.
Cost is the biggest cause for debate between active and passive investment vehicles. While passive funds have lower charges, they are of course run synthetically and cannot smooth returns or increase downside protection during falling or choppy markets. Certain trackers also struggle to consistently replicate the index, which counteracts their purpose.
Active funds, on the other hand, are overseen by a team of investment professionals and often aim to beat the wider index through alpha generation and stock-specific choices.
The counter-argument against active funds is that, despite being more expensive, there is still no guarantee for outperformance and it is common for managers to underperform their benchmarks over both long and short periods of time.
While many investors have made up their mind as to which method they prefer to use, Husselbee warns that pitting the two different types of investment vehicles against each other can mean that their portfolios won’t be as efficient as they could be.
“I think you get better outcomes by using a range of tools within the portfolio,” the head of multi-asset said.
“The way I like to think about it is the cheap beta, the trackers, they’re at one end. To use the analogy of an athletics team, they’re very much the 100, 200, 400m sprinters. These are allowing you to move the portfolios around and are perhaps offering shorter term opportunities.”
“At the other end, you have the active managers and I would say they are more the marathon runners. The holy grail of active management is consistency of outperformance year-in year-out, although in reality, it doesn’t work like that.”
Husselbee isn’t the only manager to use a blend of active and passive investment vehicles as part of a range of multi-asset products.
Toby Vaughan, head of fund management at Santander Global Multi Asset Solutions, believes that portfolios should hold a wide range of assets including those the manager is cautious on.
Currently, he is cautious on government bonds but appreciates the diversification benefit they offer, so his weighting in the asset class predominantly consists of ETFs for pure exposure purposes.
“The priority with bond exposure is to make sure we’re getting access to the diversification of duration. We’re actually going into fairly core products there and often ones that are priced efficiently because we don’t want to be exposing ourselves to too much active risk in that part of the portfolio,” he explained.
“We’re prioritising the asset class, what that brings, and we don’t want a manager taking lots of other risks because then we don’t get the diversification when we need it. In corporate bonds, on the other hand, we are allocating to more flexibly-managed funds”
Husselbee says that active managers can perform well over a cycle. This, he says, was particularly apparent during last year’s markets when active managers could outperform due to their ability to used small and mid-sized companies within their portfolios.
In a study he conducted recently, the manager found that European, Japanese and UK trackers outperformed in only four out of the last 10 years on an annualised basis. In the US, however, passives outperformed in seven out of the last 10 years.
Performance of indices over 10yrs
Source: FE Analytics
“What’s interesting is, if you then look at the performance of large-cap versus small-cap [indices] over the last 10 calendar years you’ll see that in the UK, Europe and Japan, small-caps outperformed large-caps in six-to-seven out of the last 10 years. In the US though it was only four out of 10 times that small-caps outperformed large-caps,” he said.
“People think that, when you invest in a passive fund there’s no decision to be made. Clearly from those numbers there’s a big decision to be made in terms of which part of the market you want to be invested in - it’s still important to make sure you get your strategic and tactical asset allocation right.”
Husselbee bases this decision on the dispersion in returns within various markets. Within emerging markets and Asia, for instance, there is a far greater difference between the best-performing and the worst-performing actively-managed fund, and as such, he says this is a region where it’s more appropriate to buy active holdings.
In the US though, he says that this dispersion is lower and the region therefore lends itself better to passive investment.
“The decision when you’re looking at passive funds also comes down to really understanding what the fund is tracking because they’re not all the same – it’s not a vanilla-type sector in that respect,” he continued.
“The second thing is to obviously have a close look at how they’re achieving that track record because what you want to do is minimise tracking error. In doing so you have to then look into not only the process of how they’re tracking but also the cost involved as well.”
At the moment, Husselbee predominantly uses Fidelity for tracking large-cap markets. For small-caps, however, he is using factor investing or smart beta plays, which he says is particularly good for exploiting valuation gaps over the medium-term. For small-caps in the UK, the US and Europe he uses Dimensional funds in his lower-cost portfolios so that they can also gain exposure to the smaller end of the market.
As an example of his fund selection process, he is using Jupiter European in Europe for growth, JO Hambro Continental European for value and is combining these holdings with Fidelity Europe ex UK.
In a similar fashion he is using Baillie Gifford Japanese for growth, Man GLG Japan Core Alpha for value and pairing these with the Fidelity Index Japan fund as a cheap beta play.
“We are looking to basically tilt towards large-cap versus small-cap and value versus growth. In doing so, we want to find managers that we believe consistently apply to their investment style,” he explained.
“If you want that, you’re then drawn towards managers that have longer term track records, so typically our managers will have track records of seven to 10 years and be able to demonstrate to us their consistency of style.”
“Therefore, when we start looking into Europe and start looking into Japan, you can see why we’ve chosen the managers we have. All of those managers and management teams can demonstrate many years of experience in running those particular styles.”
Since founding multi-manager and multi-asset management company North in 2005, which was subsequently bought by Liontrust in 2013, Husselbee has outperformed his peer group composite by 94 basis points with a total return of 59.18 per cent.
Performance of manager vs peer group composite
Source: FE Analytics
