The real benefits of using active managers

The real benefits of using active managers

Matthew Walker

There has been a lot of debate over the years about whether active fund managers add value, or whether you are better off investing into a low-cost alternative such as an index fund or exchange traded fund (ETF).

The reality is not as simple or clear-cut as the marketing teams on either side make it out to be. You need to be very careful about what you invest in, and therefore make informed decisions.

Caveat emptor – the principal that the buyer alone is responsible for checking the quality and suitability of what they are purchasing – is a phrase that is becoming more important than ever. In this article, we look to explore why this is the case.

First, let’s revisit the main tenants put forward by each camp:

Passive management:

Active management:

Of course, the above points are rather simplistic and there can be many nuances to each offering. And indeed, irrespective of pros and cons, each offering has its place and can be the most suitable solution for a given situation. There may be no ‘right’ and ‘wrong’ in the choices we have, they are simply choices.

So, what is it that concerns me now?

What concerns me at this particular point in time is that due to the success of low cost index type offerings, billions of dollars have been pouring into them. This is all well and good until you realise that more money buying these index funds means more money buying the ‘market’, thereby becoming a self-fulfilling cycle that drives the market up. This is great, until the music stops and the money flows reverse. At that time the market is sold regardless of merit, with the inevitable result being the market falls.

This has the potential to create more volatility in markets than may be warranted, which has a knock-on effect of potentially hurting investors. Many investors have a misconception around passive investing, thinking that they are safer there.

A significant problem I see with passive, low-cost index investing is that the success of the moment is that they are all carried a tidal wave of uninformed money. Their ‘success’ is not based on well-reasoned, fundamentally driven investment acumen and (out)performance. It’s blind faith (gambling) based on smart marketing about how cheap they are, and the fact they’re going up (for now). If someone stopped and thought about it, for even just a moment, who would invest like that? It’s great if you can time markets and they’re on the way up, but it’s the downside that most worries me and the awful impact that can have on well-meaning but ultimately less informed investors. No disrespect to anyone, but most investors do not have access to the same information, in as timely a fashion as professional investors, so it’s not exactly a level playing field. There are two sides to every trade, is how the old expression goes.

This is precisely where active managers should step up to the plate and earn their fees. Through their research a good active manager should sort the good investments from the bad and, on the whole, provide a higher quality portfolio. In a market downturn, such a portfolio should fall less than the market, that is, they should help protect your capital. Ultimately, this is a very important point to consider. It’s all well and good to make great returns but it can be irrelevant if you lose it all the next day, and we all know that putting money aside to invest is not that easy in the first place. Protecting it makes sense. Avoiding large drawdowns is essential to achieving good long term compounded returns.

As a general observation, it seems to me that as investors we’ve all become a little complacent about risk and for some reason we expect markets to go up forever, which is no surprise after a very long bull market. In this environment, low-cost investment offerings seem very attractive. Lots of stats are quoted about how few managers can add value after fees and so forth. It’s a tough gig for any active manager when money pours into markets, sometimes without merit. What can they do? Abandon disciplined investment fundamentals and follow the markets?

But we all know, or at least those of us that have been around long enough or have thought about it, that markets do not go up in a straight line. There have always been periods of significant dislocation throughout history, in every market, be it shares, property or fixed interest. Remember the GFC just a short 10 years ago? It would be more than a little naïve to think it won’t happen again. In fact, despite what the general media and markets are telling us, there are very significant risks investors should currently be considering, for example: rising geopolitical risks, likely rising interest rates in much of the developed world, excess government stimulation following the GFC creating distortions in markets and valuations of some assets, most notably the Australian housing industry and US equity markets. Astute investors are being cautious for a reason. Whilst there are always opportunities within markets, if you’re buying the market, as in using an index fund, then there is no hiding the fact you’re taking a lot of risk at the moment.

Is it really worth the 0.X per cent cost savings? Food for thought, at the very least.

Now of course not every ‘active’ fund will do well and protect your capital and there are good and bad managers out there, so this is where the ‘caveat emptor’ phrase comes back into the conversation. Careful selection is warranted and absolutely necessary. Take the time to find the good managers. They are out there. We know because it’s our job to find them.

Find the managers that match up to what you want to achieve in your investment portfolios, and that you can trust to look after your money. It’s worth the time and effort to think about these things. It is less effort than it would be to replace any lost capital anyway.

Alternatively, find someone that can help you match up good investments with what you want to achieve. It’s your money. How actively do you want it looked after and are you prepared to pay someone to protect your capital and do a good job of managing it for you?

Having worked as a specialist financial planner since 1991, Matthew has extensive experience in providing advice to successful individuals such as senior corporate executives, professionals and self-employed business executives. His plain-English approach to complicated financial and regulatory subjects has won him a loyal client following.

The opinions expressed in this content are those of the author shown, and do not necessarily represent those of No More Practice or its related entities. This information is general in nature and does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness having regard to these factors before acting on it. To view our full terms and conditions, click here.

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