Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.
There’s a war going on within the fund management industry. On one side stands the traditionalist active managers. They believe the best way to invest is by ‘actively’ picking and choosing their investments. They’ll usually operate within some kind of remit - perhaps they manage a European small companies fund - but ultimately it’s their job to determine where lie the best opportunities for their fund’s investors.
Against them has risen a new tide of ‘passive’ strategies. Passive funds usually try to mirror the performance of a given index or benchmark. There’s little (if any) scope for a manager to cherry-pick investments to enhance performance. This makes the process simpler, smoother and, consequently, often cheaper. That’s a potent armoury that active managers are struggling to resist.
Right now, passives are winning. According to Morningstar, around $94 billion poured into US passive funds in April, and only $30 billion into active. Most of that went into Exchange Traded Funds, or ETFs. Whereas standard passive “tracker” funds are priced according to the Net Asset Value (NAV) of their underlying holdings (much like any active mutual fund or OEIC), ETFs are exchange traded, meaning their price is subject to constant fluctuations in investor demand.
It’s easy to see why ETFs are gaining so much attention right now. Because there’s no management team controlling the investment decisions, the charges on an ETF are typically much lower than those on active funds. According to Unbiased, the average cost of a passively managed fund is around 0.15%, significantly less than the 0.67% average for active funds.
There’s a large breadth of choice as well. As well as stock ETFs, there are also bond ETFs which track the performance of a bond index. For instance, on the Select ETF list of our analysts’ favourite ETFs, you’ll find the Vanguard UK Gilt UCITS ETF, which offers exposure to UK government bonds.
Some track alternative investments such as the iShares Physical Gold ETC, which mirrors the gold price. Exchange Traded Commodities like this differ slightly from more conventional ETFs in that they’re structured more like a bond than a fund, but in practice they function similarly to standard ETFs.
Nor are stock ETFs limited to conventional benchmarks like the S&P 500 and FTSE 100. Increasingly sophisticated ‘actively passive’ ETFs will track a proprietary index around an investment theme - renewable energy companies, for instance.
At this point, the distinction between active and passive fund becomes increasingly hazy. These ETFs are often just as expensive as actively managed funds and offer far fewer diversification benefits than an ETF investing in a wide-ranging stock index.
Still, it goes to show that there are all kinds of ETF out there to meet investors’ needs. Which begs the obvious question: why bother with active funds at all?
That question becomes more pertinent when you consider how markets look right now. Many investors may look at the recent performance of stock indexes like the S&P 500 and wonder why they should pay an active manager.
In markets such as these, a manager’s role may look redundant. But markets such as these are a rare thing, and they may not last for long. As volatility makes its unwelcome return, inflation anxieties rise, and the outlook becomes progressively more muddled, active management begins to restate its case. Those market trends that many ETFs track are fragmenting. It’s unclear which of growth or value, defensive or cyclical, big or small, is in the ascendancy right now. Even the clean energy theme looks troubled - clean energy stocks have become as crowded as tech stocks were before the dotcom market crash in 1999, according to MSCI.
Investment opportunities still abound, but it’s becoming harder to spot them. A trained eye could have more chance than a broad-based tracker. The advantage of having an experienced professional picking investments on your behalf remains a compelling one.
Since both strategies have their benefits, investors would be wise to consider both. ETFs can be a great, low-cost way to gain diversified exposure to a core set of investments. An active fund will help to add that extra, human, edge. There’s no need to fight here - active and passive strategies should be a marriage made in heaven. If you want some ETF ideas, check out our Select ETF list here.
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Select ETF is not a personal recommendation to buy ETFs. Equally, if an ETF you already own is not on the list, we’re not recommending you sell it. You must ensure that any investment you choose to invest in is suitable for your own personal circumstances. Overseas investments will be affected by movements in currency exchange rates. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to a Fidelity adviser or an authorised financial adviser of your choise.
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