The active versus passive debate has continued to divide opinion among investors, yet Thomas Miller Investment believes its blended approach captures the merits of both strategies. 
The firm’s model portfolio range uses both active and passive vehicles to gain exposure to markets, particularly the US and UK.
In the UK, as discussed in a previous article today, the firm uses four active managers but has outperformed over the past year thanks to its passive vehicles.
Head of collections research Jordan Sriharan said: “We have owned, traditionally, a mix of passive and active managers. Passive as you know is the index and that has a sectorial bias to the miners, the oil stocks and the financials.”
Performance of indices over 1yr
Source: FE Analytics
As the above graph shows, mining and oil stocks in the UK have outpaced the FTSE All Share over the past year, while the financials index was also higher.
This has been thanks to a large bounce back in commodity prices, which plummeted in 2015, as well as renewed expectations of interest rate rises in the US and a stability to rates in the UK and Europe.
“The active managers who are generally a bit more mid-cap-focused are more naturally underweight those sectors and they provide a balance to that,” Sriharan said.
“We typically use the L&G through the course of time and have used them for quite a few passive products. They are quite competitive and broadly speaking are a name that we have trusted for a long time.”
“It’s almost contrarian, you’re forced into buying areas that you may not like,” head of private client investment management in the UK Andrew Herberts added.
“Realistically we would be about a third invested in passives and we are currently sitting above that.”
Additionally, the pair say UK active managers are structurally overweight to the mid-caps meaning they see them as more of a ‘beta play’, in-line with the FTSE 250. The index has outperformed the FTSE 100 on a consistent basis over the longer-term but will underperform when out-of-favour stocks outperform like they did last year.
“Last year we owned more passive than we owned active managers in our UK equity space and that helped our UK part to outperform,” he said.
“What we’ve started to do is look at after [Donald] Trump was elected – and that was significant not because he was elected but because sector dispersions started to be built into the returns within different equity markets – is whether to move back out of passive into active management.”
The other area the team look to use passives effectively is in the US, where they are currently using it as a stopgap to gain exposure before finding an active manager they are 100 per cent confident in.
“Everyone will tell you how efficient the American market is and typically people will use passives in the US,” Herberts said.
“We’re not averse to that view but there are some good US fund managers out there and when we are looking at being a little bit smarter then we’ll go out and try and find active managers with biases that we want to back.
“An example of what we are doing in the US at the moment is we sold down some of our general US tracker exposure because we wanted to take some mid-cap exposure.”
Over the long-term, the mid-cap index has outperformed the large-cap, but over the last three years this trend has reversed, with larger companies outperforming.
Performance of indices over 3yrs
Source: FE Analytics
“In the US the larger tech element of the index has meant that passives outperformed there when some managers have been in deeper value names and less driven because they are scared of the valuations in tech,” Sriharan said.
“This is another example of if you thought valuations in tech were a little bit toppy then you might move into an active manager who was underweight tech names.”
While the managers are not yet taking an active bet on the tech industry they are looking for mid-cap exposure thanks to the improving US economy.
“Actually the fundamentals are looking pretty good in the US and Trump is a lucky president to an extent a bit like [Bill] Clinton in that he is coming into a recovering economy,” Herberts said.
“There are some measures he will take to help the domestic US and we think the domestic US is pretty healthy – so rather than have a broad exposure we wanted to go mid-cap.”
“We haven’t done the necessary work to find the right mid-cap manager because it is so difficult to outperform in the US, so we’ve gone to an S&P 400 ETF so that gives us the mid-cap exposure.
“It allows us to say that we are playing the right theme and now actually we want an active manager because there is more things they can do in that space so if we can find one we like we will buy it.”
He added: “We have had biases in the small and mid-cap space but we would rather have an active manager because there are more value opportunities in there and we are happy that an active manager will be able to find them.
“In the same way we prefer to use active managers in emerging markets, Asia and Japan because they are more aware of the ‘elephant traps’ in those types of markets that are more prevalent than in an S&P 500 or Eurostoxx index.”
Overall, Herberts says they use passive or active funds depending on the business cycle of a market. With quantitative easing measures seen since the financial crisis broadly sending most markets rising, active management has struggled to add value and has been more conducive to passive strategies.
Performance of indices over 10yrs
Source: FE Analytics
“Now we think that the cycle is just starting to turn in certain parts of the economy which plays into an active managers hands more easily,” said Herberts.
“In the US, where we think we are closer to the end of the cycle than we are in Europe for example, we are going that way and looking at managers who will outperform the S&P after years of underperformance.
“Whereas in Europe we have used passives and because of the QE story there, I think we’re less likely to use an active manager in the next six months.”