Wednesday, 12 October 2016

What’s wrong with active investment funds in 2016?

Given that active funds have struggled to outperform their benchmarks over recent months, why has this year has been particularly difficult for active managers? Only 25 per cent of funds within the IA UK All Companies and IA UK Equity Income sectors have managed to outperform the FTSE All Share index year to date, according to data from FE Analytics.

Out of these funds, more than a quarter of them are also passive investment vehicles, suggesting that active managers have had a particularly difficult time in 2016. Ultra-loose monetary policy, a cheaper pound and a surprisingly positive market reaction following the EU referendum results have been cited as reasons that the FTSE All Share index has surged over recent months.

Since the announcement of a vote for Brexit on 23 June the index has returned 9.12 per cent, despite the outcome widely being seen as being negative for financial markets prior to the vote. While the index has done well though, actively managed funds have struggled to outperform their benchmarks, with the IA UK All Companies and the IA UK Equity Income sectors underperforming the FTSE All Share by an average of 5.05 and 5.52 percentage points respectively since the start of the year with returns of 7.6 and 7.13 per cent.

This trend can also be seen outside of the UK, with the IA Global and IA Global Equity Income sectors achieving approximately 87 per cent of the returns of the MSCI AC World index year-to-date. What’s more, figures from the Investment Association shows that equity funds suffered outflows of £2.2bn in July, which is the most recent time period the data covers.

Given this backdrop, why have actively-managed funds struggled so much in 2016 when so many have managed to outperform their benchmarks during previous years?

Two things have happened this year: high beta has been rewarded, and of course, we have had a Brexit result. Both of these did not suit the style of managers who were more focused on quality and less cyclical earnings. Also a number of managers that positioned themselves for a ‘Bremain’ vote and thus struggled in the sharp rally just following the referendum.

When markets are largely driven by macro events, as in 2016, it makes it difficult for active managers to consistently outperform. Not only did the ‘leave’ vote lead to many market areas being sold off indiscriminately, a number of other macroeconomic factors such as the changing oil price and Saudi’s decision to limit production meant that unloved sectors suddenly surged. 

It could be argued that, if there are indeed periods where actively-managed funds are likely to underperform, it could be more cost-effective to hold passive investment vehicles instead such as index tracking funds. The trend towards passive funds has been growing for years and will continue to do so, given that most active managers tend to underperform passive funds over time generally.
Ultimately investors need to identify the above-average active managers that are out there and in particular avoid buying and selling them at the worst times. If they do these two things, they can achieve superior outcomes with active than they could with passive. While some investors might be tempted to reduce their active exposure and buy into passives given the recent underperformance of many funds, our preference is for both types of investment vehicle to be dynamically blended to maximise returns.

A change in sentiment based on short-term fund performance is likely to do more harm than good to investors’ portfolios, despite the challenging macroeconomic climate. As always, seek professional advice where appropriate.

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