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There’s No Such Thing as Passive

Jupiter’s Peter Lawery explains why passve investments are more active than they seem

 

The debate about active versus passive investment shows no sign of slowing down any time soon, Either you accept that active funds are better placed to take advantage of an improved market situation, say the new school, or else you condemn your clients to a future of under-performance, bereft not only of risk but also of opportunity.

 

Nonsense, retort the passive fans, 95% of active managers underperform their benchmarks. But now, into the middle ground, comes Peter Lawery, co-manager of Jupiter Merlin’s fund portfolios, with an interesting contention that there’s actually no such thing as a passive investment.

 

Everything’s Active

“Every choice you make requires an active decision,” says Lawery,”and, therefore, it requires careful and regular monitoring. Not to mention the ability to invest in the right areas and products at the right time.” Well yes, perhaps we wouldn’t disagree with that. Timing can be everything, though it’s unfashionable to say so.

 

The trouble with traditional passive strategies, Lawery says, is that they’re mostly agnostic to market factors such as style, capitalisation bias, quality and valuation considerations. And that, by definition, they “lack common sense” – typically taking no account of the business cycle, the credit cycle, seasonality and the interest rate cycle.

 

“All of these are observable and portfolios can be tilted to exploit or avoid certain of these factors,” he told IFA Magazine. “But if you own a FTSE 100 tracker, you just get what you are given – and a rise in interest rates for instance, which is like bubonic plague to heavily indebted companies, is just tough luck.” You can probably do better.

 

Smart Beta

In recent times there’s been growing interest in “smart beta” funds, which straddle some of the best features of both active and passive funds. Whereas “beta” looks for returns through exposure to the overall market – say, via an index fund – “smart beta” aims to build further on that. A smart beta fund generally tries to outsmart the market by passively tracking an index that isn’t capitalisation-weighted, or that offers exposure to a rules-based strategy that aims to outperform the conventional market indices. It might, for instance, be weighted toward smallcaps or other specialist interests which will outperform under certain circumstances.

 

Lawery says smart beta funds are actually not quite so dumb. “They track specialist indices that are themselves created to avoid many of the pitfalls mentioned above,” he says.  “As they have a certain amount of selectivity in them, they don’t tend to defy common sense in the same way and can, in my view, make a helpful addition to a portfolio. Still, they do lack the flexibility of an unconstrained actively managed fund.”

The Active Imperative

Jupiter, for one, has nailed its colours firmly to the active strategy mast, with all its funds being actively managed. And it thinks that genuine active management is particularly in its element right now – with managers free to take advantage of market falls to invest in quality companies that can offer attractive growth potential.

 

The Jupiter Merlin Portfolios, for instance, are multi-manager investments which cater respectively for conservative, income, balanced, growth and worldwide strategies. The group’s funds, it says, are actively managed in terms of both asset allocation and underlying fund selection. But ultimately, Lawery says, “the managers believe that the most important factor in how a fund is likely to perform is the individual who runs it.” Accordingly, they interview managers face-to-face to gain first-hand information.”

 

A slightly different approach is used by the Jupiter Strategic Bond, a ‘go anywhere’ fixed income fund that has achieved considerable growth by giving its managers the complete freedom to invest across the entire range of available fixed interest investments. Both funds have achieved popularity among advisers and their clients, says Jupiter.

 

The Curse of the Quasi Trackers

Lawery warns us to watch out for imposters among the active fund managers . “If you are looking to invest in active funds,” he advises, “make sure they’re truly active. There are many funds that claim to be active – charging quite high fees and providing returns below or just above the market average. I call these “quasi-trackers”.

 

Some of these underperformers are simply hard luck stories, he says, or maybe they’ve switched managers and so can’t be dismissed outright. But a large number are just structurally flawed and poorly managed. Between them, these slackers collectively drag the sector’s average performance below the benchmark index, which is where the bad image starts.

 

But there are a number of active managers who genuinely justify their fees, he says. And the very best are like gold dust. Finding them is difficult, he says, and occasionally disappointments can occur for no other reason than that they are making a conscious decision to be different to the index. “This difference can result in high levels of relative volatility: patience and a strong stomach are often required to realise the best potential from them over time.”

 

Commenting on the outlook for active solutions, and the ongoing active versus passive saga, Lawery says: “There is room for both active and passive strategies in individuals’ portfolios but we do believe that in fund management, as in life, you really do get what you pay for.”

 

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