The growth in popularity of tracker funds in recent years has prompted debate about the relative benefits of the passive and active approaches to investing.
Latest data from the Investment Association revealed a surge in support for tracker funds during the penultimate month of 2016, making up more than three-quarters of monthly total retail fund sales.
Sales of tracker funds reached their second highest monthly inflow on record in November 2016 garnering £1.2bn from investors out of total fund sales of around £1.5bn.
Indeed, tracker funds now account for 13.4 per cent of total industry funds under management compared with 11.5 per cent in November 2015.
“Equity trackers took in the largest share of net retail flows, £911m. No single region stood out as UK, US, Japanese and global tracker funds all experienced strong sales,” said Alastair Wainwright, fund market specialist at the Investment Association.
Passive strategies performance by sector over 1yr
Source: FE Analytics
Yet, while some industry commentators have championed tracker funds for their low costs, the debate over the merits of active versus passive investment styles has continued.
“The active versus passive debate has led to numerous studies, detailed analysis and thought-provoking theories,” Henderson Global Investors pointed out in a recent note.
“Yet, in our view, trying to establish a winner is not the right approach."
“The data and time period selected, the asset class invested in and how success is defined make for an uneven playing field.”
“What is clear is that passive funds have attracted significant inflows in the last decade and now play a major role, for better or worse, both in investor portfolios and in the functioning of global capital markets,” it added.
Henderson said academic studies into the active/passive debate typically showed recurring themes. It noted that while the average manager typically underperformed a passive benchmark, while some markets and sectors are easier to outperform than others.
Passive UK equities strategy vs IA UK All Companies over 1yr
Source: FE Analytics
The average FE Passive-rated passive investment UK equities fund outperformed the average IA UK All Companies fund over one year, according to data from FE Analytics.
The scenario was also repeated in the European equities, emerging markets, North American and property sectors.
However, passive strategies failed to outperform UK gilts and index-linked gilt strategies over one year, while sterling corporate bonds and Japanese equities strategies were broadly equal.
Indeed, among other recurring trends from the academic studies Henderson noted were consistent outperformance by some active managers, particularly by those with higher conviction positions.
As an active manager, the firm says it encourages managers to develop processes allowing them to “identify and act upon investment opportunities discovered through detailed analysis and in-house research”.
“While we are not a provider of passive investment funds, some of our managers, particularly in the multi-asset space, use passive vehicles to help achieve their investment objectives,” Henderson analysts said.
“Passives provide a quick and cheap means of gaining exposure to an asset class and can prove an effective way of expressing market direction or asset allocation calls.
“The debate, in our view, should not be around whether one approach is better than the other but focus on when to use active or passive managers.”
The costs argument is also one which the firm believes can be misleading for investors.
“The key argument for passive is that it is cheaper,” it noted. “This is generally true but, as with many of the goods and services available to us, cheaper does not necessarily mean a better outcome for the end consumer.”
It added: “In our view, it is when and how passive and active are used, and how they are blended, that will determine success.”
With passive strategies seeming likely to form an increasingly important part diversified portfolios, active managers may adopt different investment approaches in the future to justify higher fees.
Managers may seek to target increased engagement with companies and promoting long-term value creation, according to Henderson.
Similarly, the firm believes rise in popularity amongst younger investors for sustainable investing may see more active managers embracing socially responsible investment (SRI) strategies or environmental, social and governance (ESG) criteria – which can’t easily be replicated by passive funds - when investing.
The focus on capital preservation and portfolio adjustment may also become a greater focus for active managers, according to Henderson, particularly in more volatile market conditions where they are able to alter holdings to protect investors or grow capital.