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As an investor there is a wide range of choice open to you when deciding where to put money. First of all, there are many asset types – e.g. bonds, equities and commercial property. Second, you have different methods of investing capital. You could invest directly in a company through individual stock purchases, for instance. More commonly, however, retail investors can invest in funds where money from multiple investors is pooled together and invested in multiple different opportunities (e.g. shares in lots of different companies).
This latter approach is very popular since it lets more “ordinary people” invest in companies that might otherwise be unreachable. An individual Facebook share, for instance, is $329.15 (US) at the time of writing. Yet by investing in a US tech fund with other investors, you could invest in a company like Facebook without needing to buy a full stock. However, whilst funds open doors like this to investors, they can be complex to understand since they operate differently and can come in many forms.
The two broad categories that people use to describe fund types are active and passive. There are features which tend to distinguish the two – although they can overlap – and each type has its fierce proponents and detractors. Below, we look at some of the arguments for and against both active (or “tracker”) and active funds. We hope you find this content useful. If you’d like to find out more or discuss your own financial plan with us, please contact our team for more information or to access personalised financial advice:
020 8366 4400 or enquiries@cedarhfs.co.uk
Active funds
This type of fund employs a specialist manager and team who decide which companies will be invested in – on behalf of investors. With this arrangement, the fund manager(s) can use their skills, experience and research to try and anticipate which companies will do well – committing investor capital there – and which are likely to underperform (leading to investor capital being withdrawn before the “fall”). The common argument in favour of this set-up is that active fund management allows investors to “beat” a market crash by pulling capital out of markets which are about to fall during a crisis. This helps to avoid investor losses and could even lead to gains amidst wider economic and market turmoil.
Whilst this sounds good in theory, it is difficult for fund managers to achieve in reality. One study revealed that 82% of managed funds failed to beat the market over a 20-year period. This may sound bad enough, but it only applies to those funds which survived this timeframe. Many active funds do not last. Despite this, however, there can still be a place for active fund management in certain investor situations. In 2021, for instance, most “ethical” (or ESG) funds are still actively managed. As such, an investor who wants to lean their portfolio towards specific environmental, social or ethical causes may need to consider including a sizable portion of actively-managed funds into their wider asset allocation. It is also true that, sometimes, active funds do live up to their sales pitch and deliver market-beating returns. In early 2021, for example, UK large-cap equity funds returned an average 8.3% return over the previous 6 months – as opposed to 5.1% achieved by UK large-cap passive equity funds.
Passive funds
This fund type simply follows the movement of a particular market index – such as the S&P 500 in the US, or the FTSE 100 here in the UK. As such, no expensive fund manager or research team is needed to decide which companies to include in the fund, and which to remove. This makes passive funds – sometimes also called “tracker” or “index” funds – typically cheaper to invest in. The downside, however, is that the fund follows its respective index wherever it goes – including downwards, during a stock market fall (a “bear market”). In 2020, the FTSE 100 index closed at 6460.5 on New Year’s Eve; 14.3% down over the duration of the year. Those index funds which mirrored the FTSE 100, therefore, will have also fallen similarly in this period.
Whilst this may sound bad, however, there is strong evidence to show that passive funds tend to outperform their actively-managed counterparts in the long term. This is because, after a crisis, markets usually recover and supersede their previous high-points. The S&P 500, for instance, has been through a lot over the last 90 years – including World War II, the Cold War and multiple economic crises. Yet it has grown from 271.23 in 1928 to over 4,204 today in 2021, returning an average annual return of 7.3%. For patient investors willing to ride out stock market shocks and declines, therefore, investing in passive funds can be a great way to grow equity wealth over the years and decades.
Conclusion
As you can see, investing in funds can be quite a complex process involving careful decision making. A financial planner can really help you work through the various intricacies and ensure you craft a portfolio which reflects your values, investment horizon, goals and risk appetite.
Interested in discussing your financial plan with an experienced financial adviser? Get in touch today to discuss your financial plan with a member of our team here at Cedar House via a free, no-commitment consultation:
020 8366 4400 or enquiries@cedarhfs.co.uk