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Passive funds rule the roost says AJ Bell’s Khalaf


AJ Bell has published the results of its latest Manager versus Machine report which finds that only a third of active equity funds (34 per cent) beat a passive alternative this year.

The firm found that active outperformance was particularly sparse in the US, Global, and Asia Pacific regions. Longer term figures suggest active managers have on average beaten the passive machines across most sectors. 

But the firm writes that in the crucial US and Global sectors, passive funds have won the last decade hands down, and these sectors now account for GBP270 billion of investors’ money.

Laith Khalaf, head of investment analysis at AJ Bell, says: “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 GBP270 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 10-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 per cent 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.”

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