While it may not have felt like it, equities have been a good place to be invested in over the past three years.
The MSCI World index is up 24.4 per cent over the period, with the vast majority of funds in the IMA equity sectors delivering in excess of more than 20 per cent to investors.
Markets may not be as cheap as they previously were, but the general sentiment among fund managers is very positive, with many of them pointing to an improving macro outlook and strong company fundamentals as reasons to be positive.
The likes of F&C’s Gary Potter, Threadneedle’s Simon Brazier and Schroders' Richard Buxton believe the market is entering the early stages of a bull run.
While there are many talented active managers available who are capable of making money regardless of which direction the market will take, FE Trustnet research and industry experts suggest investors may be best off investing in a tracker if predictions of a sustained rally prove correct.
Rob Morgan (pictured), analyst at Charles Stanley, points out that passive funds make sense for investors from a psychological point of view, because there is little point in risking underperformance with an active manager.
"If the markets are going up, there’s always the risk of underperformance when you invest in an active fund," he said. "You’ve got the issue of costs as well. Although the best fund managers show their mettle in both rising and falling markets, arguably it’s less important in rising ones."
Morgan also points out that active managers cannot always take full advantage of bull markets, because they are constrained in what they can hold.
"Bull markets are sometimes driven by the large caps, as we saw in the late 1990s with large caps such as Vodafone leading the way," he explained.
"Active managers can only invest up to 10 per cent in a single stock, but in practice it’s quite rare for them to hold more than 5 or 6 per cent. This means they can find it difficult to keep up."
"They sometimes have sector constraints as well," he added.
Buxton, one of the UK’s highest-profile active fund managers, told FE Trustnet in an interview last year that trackers are in general better suited to rising markets.
The manager of the £3.4bn Schroder UK Alpha Plus fund, who is due to join Old Mutual in June this year, believes there is a strong argument for buying the index in rising markets, such as those seen in the 1980s and 1990s.
He correctly predicted a poor decade for equities back in 2002, which is why he decided to launch a high-Alpha portfolio.
While he has no plans of packing it all in and buying the index, he says a passive strategy is becoming more attractive.
"In the 130 years of stock market history, we’ve had escalator periods of momentous growth followed by 10 to 15 years of going nowhere," he said.
"Most recently we had the boom years of the late 80s and 90s when managers opted for portfolios with little tracking error because everything was going up."
"In 2002 when the fund was launched, I felt we were set for a period of going sideways, which has been largely true. As a result, I opted for a high-Alpha approach."
"We may have a few more years of this, but I think we’re far closer to the end than the beginning."
FE data appears to support Buxton’s theory. Between 1990 and 2000, the average UK All Companies fund vastly underperformed the FTSE All Share, as seen in the graph below.
Performance of sector and index 1990 to 2000
Source: FE Analytics
In the subsequent decade, which bore very little fruit for equity investors as a result of the dotcom crash and financial crisis, the gap was far smaller.
The UK All Companies sector was neck-and-neck with the index until mid 2009, when the FTSE All Share rebounded sharply and easily outpaced the sector.
Here are three passives that may be worth considering for anyone who is in Buxton’s camp, but who does not want to run the risk of underperforming through an active manager.
All are in Vanguard’s range, which head of FE Research Rob Gleeson considers to be "the only trackers worth holding".
Vanguard FTSE UK Equity Index
This £743m tracker has been effective at matching the FTSE All Share since its launch in June 2009.
It is up 77.81 per cent over the period, falling short of the index by less than 1 percentage point.
The fund has been just as precise over one and three years.
Performance of fund vs index since launch
| Name | 1yr returns (%) | 3yr returns (%) | Returns since launch (%) |
|---|---|---|---|
| FTSE All Share | 19.7 | 26.63 | 78.52 |
| Vanguard FTSE UK Equity Index | 19.64 | 26.4 | 77.81 |
Source: FE Analytics
Like all Vanguard vehicles, it employs full replication, meaning that it owns every stock in the index and constantly trades them to make sure they own the right weighting.
Very few asset managers have the resources to do this, particularly with an index as diverse as the FTSE All Share.
HSBC, BP and Shell are the three biggest holdings in the portfolio.
Another big advantage of Vanguard funds is that they are very cheap, which helps keep the tracking error down as charges significantly erode performance over the long-term.
This one is available for an ongoing charges fee of just 0.15 per cent, although investors would have to cough up a minimum investment of £100,000.
It is available for a far lower investment through a platform, although charges are also higher.
Vanguard FTSE UK Equity Index is headed up by E David Kirby.
Vanguard FTSE Developed World ex UK Equity Index
This fund tracks the performance of all developed equity markets, with the exception of the UK, so would go nicely alongside the fund mentioned previously.
The £694m fund has returned 77.87 per cent under Gerard C O’Reilly, who has run it since its launch in June 2009. This is compared with 82.06 per cent from the FTSE Developed ex UK index.
Unsurprisingly, Vanguard FTSE Developed World ex UK Equity Index is predominantly invested in North America, making up 60.5 per cent of AUM.
Around 20 per cent is in Europe, 8.9 per cent is in Japan, 5.9 per cent is in developed parts of the Asia Pacific such as South Korea, with the rest split between the Middle East and Australasia.
The biggest single stock position is Apple, with Exxon, General Electric and Microsoft not far behind.
This tracker has an OCF of 0.3 per cent, but again retail investors will need to use a platform for a reasonable minimum investment.
Vanguard Emerging Markets Stock Index
This is one of the few passive funds that tracks the performance of emerging markets, which is inherently difficult to do given the lack of liquidity in the sector and higher levels of volatility.
However, once again, Vanguard has been very effective at tracking the index. According to FE data, it has delivered 61.64 per cent since its launch in June 2009, falling short of its MSCI Emerging Markets sector by just 2.6 percentage points.
Performance of fund vs index since launch
Source: FE Analytics
Manager Christine Franquin has around two thirds of her €5bn fund in emerging Asia, with the rest in South America, emerging Europe, the Middle East and Africa.
Samsung, Taiwan Semiconductor Manufacturing and China Mobile are the fund’s three biggest holdings.
It is a little more expensive than the other two, although the OCF is still very low, at 0.55 per cent.