AJ Bell: UK ‘good home’ for active fund managers

The UK has been a “particularly good home” for active managers of open-ended retail funds, with the average active fund returning 134% over 10 years compared to 95.6% from the average passive fund.

That’s according to the latest report on active management versus passive management from Salford-based investment giant AJ Bell, which the firm calls the “Manager Versus Machine Report.”

The report analyses the performance and charges of around 800 open-ended retail funds across seven popular equity sectors.

It said that while only 34% of active equity funds beat a passive alternative in 2021, “longer term figures suggest active managers have on average beaten the passive machines across most sectors.”

For 2021, AJ Bell said active fund outperformance “was particularly sparse in the US, Global, and Asia Pacific regions.”

The firm said 2021 “has been a pretty grim year for active managers.”

It said that “in the crucial US and Global sectors, passive funds have won the last decade hands down, and these sectors now account for £270 billion of investors’ money.”

However, Laith Khalaf, head of investment analysis at AJ Bell, said: “The UK has been a particularly good home for active managers, with the average active fund returning 134% compared to 95.6% from the average passive fund over 10 years, a significant differential that cannot easily be explained by survivorship bias alone.

“There are some other factors in this sector which can go some way to revealing why active managers have performed so well against passive alternatives though.

“The IA UK All Companies sector is home to a significant number of funds which focus on the midcap area of the stock market.

“Indeed, of the ten best performing UK funds over ten years, four explicitly target the FTSE 250 as their benchmark index, and many of the other top performing funds have a multi-cap approach which sees them invest heavily in small and mid-cap companies.

“Not only have small and mid-caps significantly outperformed the big blue chips over the last ten years, they are also a fertile hunting ground for active managers to pick out hidden gems, as they are not as well scrutinised by the wider market.

“The positive midcap effect on the outperformance of active managers in the UK is also exacerbated by the fact that some passive funds track the blue chip FTSE 100 index, rather than the wider FTSE All Share.

“The UK All Companies sector is also one of the oldest, and that has some bearing on the passive funds that are available in this area too, with some higher charging legacy funds helping to lower returns across these funds as a whole.

“Whereas the cheapest UK tracker fund in the sector costs just 0.05% per annum, there are a number of funds which cost over 1%.

“When looking at performance for both active and passive funds, we have used median instead of mean averages in order to mitigate the effect of outliers like this within the data sets.

“However, inevitably there will still be some downward performance pressure from higher charging passive funds in the UK, compared to a sector like the US, where the lowest fund charge is also 0.05%, but the highest is a much more competitive 0.29% per annum.

“While the effect of mid cap performance and higher charging tracker funds do tilt the balance in favour of active funds in the UK, these factors are still present in the UK fund investment universe, and so are a fair representation of the investment opportunity set open to investors in UK funds.”

Khalaf added: “2021 has been a pretty grim year for active managers, with passive funds ruling the roost and delivering better returns for investors on average.

“Outperforming active funds were particularly sparse in the Global and North America sectors, which are hugely important for investors because they are two of the most popular areas for investment, accounting for £270 billion of investors’ money.

“In the North America sector, fewer than one in five active funds outperformed a passive alternative in 2021, and the picture is not much improved when looking over a ten-year period.

“Longer term underperformance from active funds in these sectors suggest there is a structural reason why relatively few funds outperform a passive alternative.

“This is no doubt partly down to the fact the US stock market is poured over by so many analytical eyes and so active managers naturally find it more difficult to find an edge.

“But the continued market domination by a small number of large tech stocks may also be feeding into the equation, reinforcing the implicit passive principle that big is beautiful, and punishing those who take a dissenting view with their portfolios.

“This issue has increasingly affected the Global sector too, seeing as the US stock market has grown to such an extent that it now makes up around two thirds of the world index.

“Global tracker funds therefore increasingly resemble US tracker funds, making it more difficult for active funds to compete in this arena while the US maintains its ascendancy.

“If the raging US bull market comes a cropper though, this performance differential could get turned on its head, seeing as the average global active fund is around 8% underweight the US compared to passive peers.

“As ever, averages and aggregate data can’t tell the whole story, and individual investors do have the opportunity to improve their own lot through fund selection, both active and passive.

“For active investors this means picking seasoned fund managers who have proved their performance potential, or their ability to deliver a set outcome such as a high level of income or a low level of volatility, though of course there can never be a cast iron guarantee of future performance.

“For passive investors, fund selection entails picking funds that track appropriate market indices effectively, at the lowest price possible, as charges will be a key determinant of returns.

“In the UK sector in particular, there is still an awful lot of money invested in tracker funds that are nowhere near the competitive end of pricing, in some cases charging ten or twenty times more than the cheapest fund on the market, year in, year out.

“Over a lengthy period, those higher charges are going to eat into passive investors’ wealth.

“Many investors of course choose to mix and match passive with active strategies, and our performance analysis suggests where each strategy might be in its element.

“In particular, within the Global and US sectors, active funds have failed to bring home the bacon compared to index funds.

“That’s by no means true of all active funds and there are some leading lights of the fund management world with offerings in these areas, for example Baillie Gifford and Fundsmith.

“While the long-term performance numbers from the US and Global sectors look pretty damning for active investors as a whole, it’s worth bearing in mind that market performance in the last ten years has been heavily influenced by ultra-loose monetary policy and the digitalisation of the global economy.

“Should one, or both, of those trends moderate or even go into reverse, life might not prove so breezy for the passive machines that simply invest money according to the size of companies in the market.”

About the Author

Mark McSherry
Dalriada Media LLC sites are edited by veteran news journalist Mark McSherry, a former staff editor and reporter with Reuters, Bloomberg and major newspapers including the South China Morning Post, London's Sunday Times and The Scotsman. McSherry's journalism has also appeared in The Washington Post, The Guardian, The Independent, The New York Times, London's Evening Standard and Forbes. McSherry is also a professor of journalism and communication arts in universities and colleges in New York City. Scottish-born McSherry has an MBA from the University of Edinburgh and a Certificate in Global Affairs from New York University.