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Pension Funds

Active or Passive?

Pension Funds

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Passive investors can be Dynamic

“Properly measured, the average actively managed dollar must underperform the average passively managed dollar, net of costs. Empirical analyses that appear to refute this principle are guilty of improper measurement.”
-Dr William F “Bill” Sharpe, Winner of Nobel Prize in Economics 1990

The compound cost of asset management fees and charges makes a significant impact to the performance over time; the longer the time frame and the higher the costs as a percentage of assets, the more pronounced the effect. 

Research has consistently shown how ‘active’ stock picking detracts from performance. One study ‘The Case for Index Fund Investing for UK Investors’, published by US investment manager Vanguard in March 2014, found that the majority of investment managers in most asset classes underperformed their benchmark. The longer the time period, the more managers fail to beat their benchmark.  Using the data in this report, Charles Stanley Pan Asset calculates that the chances of choosing 11 managers – one in each of the asset classes considered by Vanguard’s study – which all outperformed their benchmark over five years is approximately 0.01%. The chance of less than half of these managers beating their benchmark is 92%.

In The Governance Revolution (2013) and The Case for a Passive Fund Premium (2014) the Charles Stanley Pan Asset team published research which shows the extent to which passive funds beat active funds in the same asset classes. The study found that, on average, over the time periods considered, passive funds beat active funds by 1% a year.

But while these studies show the ineffectiveness of stock selection, equally studies have shown the importance of asset allocation. Asset allocations cannot be indexed – there is no passive option – and they are likely to have the most significant impact on overall returns.

Many have approached this question from an academic angle and many studies have been carried out and published on the subject over the past 30 years.  Above is a selection of the findings from studies covering a range of underlying geographies and fund types.
The results are unequivocal and clearly demonstrate the importance of asset allocation.  It may seem strange to see that Asset Allocation has accounted for more than 100% of long-term return in most cases, but this reflects the impact of the higher underlying costs associated with the ‘active’ or stock-picking element of the investment decision which detract from long-term returns.

Our conclusion is clear; the focus for investment management should be on asset allocation, not stock selection. That is why we developed our successful dynamic asset allocation process using passive index-tracking funds. Our process is to be ‘active’ asset allocators and ‘passive’ stock pickers’; we firmly believe this to be the most effective and efficient process for long-term institutional investors.

Percentage of managers who under-perform the index

Source: Vanguard

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