Tom Caddick, Head of Global Multi Asset Solutions at Santander Asset Management, explains why the cost-effective ‘supermarket sausages’ you can get from your average passive fund supplier might not necessarily match the personally tailored services you can get from the ‘local butcher’ who really knows what his clients want.
Tom Caddick will be presenting on this theme to the IFA Magazine Roadshow events in London and Manchester, on 30th April and 7th May respectively.‘Why we Still Need the Local Butcher’is a refreshing look at how the growth of the passive market is driving fund manager focus and behaviour in the active sector.
Introduction
As the use of passive management strategies has increased over the last decade, so too has the debate surrounding the pros and cons of active and passive strategies.
Following RDR, passive features now tick many boxes with their core features, providing simplicity, transparency and cost efficiency. As a result, they are providing a healthy challenge for the active fund managers. Product innovation and technological developments have brought about new opportunities and delivered a wider range of passive vehicles, helping to persuade many investors that they are a safer vehicle than actively managed funds.
The industry has the habit of talking about the active versus passive debate in a fairly binary way, where it has become almost a philosophical decision about what your position is. Ultimately, however, we believe the debate is more complex than this.
Multi-Dimensional
One of the significant differences between active and passive strategies is that passive strategies are one dimensional, whereas active management benefits from a multi-tiered investment process. The active versus passive debate overly focuses on one area of measurement of the investment strategies: costs.
These costs are often at the centre of the argument for passive management strategies, and are often cited as one of the main reasons for underperformance among active fund managers. There is no denying that passively managed funds are generally cheaper, but focusing solely on costs ignores the tailored approach that active management adopts.
The ability of active managers to deliver added value has become progressively more difficult in these challenging and increasingly efficient markets. As passive strategies have grown in popularity, space between cheap beta and more expensive beta plus has emerged for active fund managers to utilise. Active fund managers now have the challenge of demonstrating their expertise within this ever more challenging market.
A Wider Process
The debate surrounding active versus passive falls under the spotlight after particularly strong or particularly weak stock market performance. During these periods of time, one strategy has generally performed better than the other, giving its supporters reason to glorify its success.
We believe that the active versus passive debate is far too narrow, and that this decision is only part of a much wider decision making process. There are a number of drivers of both risk and return on a portfolio, ranging from the asset allocation approach, the strategy taken within each asset class, the degree of risk being taken, and the investment vehicle(s) used to access the market.
The active versus passive debate overly focuses on the last point, whereas a highly active approach can be taken on portfolios whilst using passive vehicles in the final implementation of these decisions.
Within multi-assets, asset allocation aligns the portfolio with its long term risk and performance objectives. Therefore, when it comes to the investment selection, the decision regarding active and passive is secondary to that regarding the asset allocation.
It is worth noting that in some asset classes, only active management is appropriate as it offers undeniable advantages such as flexibility, the ability of hedging to insure against losses, risk management, and tax management.
The growth of passive strategies has driven the need for alpha specialisation, meaning that active managers now need to justify their fees by identifying and capitalising on the gaps between beta and beta plus whilst remaining in line with their investment objectives and providing real value to the investor.
Blended Building Blocks
At Santander Asset Management, we believe in blending building blocks to combine both active and passive management in order to build a strong, diversified and efficient portfolio that suits investors’ needs. We also believe that blending active and passive management strategies should be integral to the overall portfolio construction process.
Research has found that the extent to which active outperforms or underperforms passive management heavily depends on the sector*. This emphasises the importance for active managers to efficiently identify and incorporate the correct blend of active and passive, depending on the sector.
The implementation of a blended approach can be an efficient and flexible tool to control the risk of a portfolio; tactical switches between active and passive can be used to decrease the level of risk allocated to the underlying assets.
However, it is also important to remember the rationale behind using a blend of active and passive management vehicles. The characteristics of the market environment, the quality (cost efficiency) of the passive vehicles, and the valuation of the asset class are just some of the factors that we consider before concluding at a level of blended building blocks.
The Local Butcher
We maintain our agnostic stance within this debate, and we continue to believe in active management, but it is equally important to note the role that the increasing development of passive management plays in enhancing the competitiveness of the fund management industry. This organic competition is important for the improvement of investment products and also highlights how active managers can utilise passive vehicles to access markets in an appropriate and efficient manner.
The effect that passive vehicles have on active management can be related to the part the local butcher plays in the supermarket industry. Where the supermarkets are convenient, simple, and cost efficient (much like passive management vehicles); the local butcher provides products of a higher quality, with greater flexibility with regards to sourcing their produce. Loosely, this represents the active versus passive scenario, whilst the supermarkets are appealing to the vast majority, they create increased competition, causing the local butchers to become more competitive in terms of their product selection and fees and charges; much like what is happening to active management strategies.
Tom Caddick is Head of Global Multi Asset Solutions at Santander Asset Management, heading a team of over 20 investment professionals across four locations with in excess of €11 billion assets under management and the same again under advice.
