Increasingly, investors are using the whole range of tools open to them, from direct share holdings and active funds, through to ETFs, index funds and separately/individually managed accounts (SMAs/IMAs).
ETFs have opened up access to a wide range of asset classes, all through one listed stock. Like equity funds, ETFs offer an individual investor exposure to a broader portfolio, structured to provide single stock exposure to the ‘beta’ (market performance) of the stock portfolio. As there’s no active management of the portfolio and the fund is merely tracking the index, ETFs are often cheaper investment options when compared to actively managed funds.
It’s not necessarily a binary market, where investors decide to go with one option or the other. From the consumer’s point of view, the growth of ETFs has presented them with more choice and the ability to use core-satellite strategies in a far more targeted fashion. Blended portfolios – not just of funds but also of active and passive philosophies – are increasingly the norm. In this environment, an active fund has to clearly articulate where and how they can add value to a client’s portfolio.
So what are the benefits of an actively managed fund?
Active managers not only give investors the opportunity to buy into a diversified portfolio, they’re also effectively selling the expertise and intellect through which their fund aims to beat the index. With many years of experience analysing stocks, including company data and corporate strategy, the managers are able to assess value in listed entities, ideally before the ‘herd mentality’ has kicked in and the stock has attracted mainstream investor interest, allowing the manager to take advantage of potential mispricing opportunities.
Whilst on paper an actively managed fund may appear more expensive than an index fund or ETF, investors are paying the active manager to generate alpha (returns above those of the market index). The manager will assess the investment fundamentals of a listed stock with the ultimate goal of out-performance of the benchmark, something that an index fund or ETF cannot deliver. By viewing out-performance as a long-term goal, an actively managed fund can help investors avoid short-term market volatility created by the inevitable ‘market noise’ and take defensive measures if they believe the market may take a downturn.
It also makes sense for investors to buy an actively managed fund in the most inefficient part of the market; those under-researched stocks where expert active management can potentially add the most value to an investor’s portfolio. There are a host of managers who can demonstrate consistent, long-term out-performance in this space, so Australia has quality options to choose from. In contrast, the area of the market that generally contains large, liquid, well researched stocks can be purchased quite cost effectively through an ETF or index fund – why would investors pay active fees in a space where it is very difficult to add alpha.
For many reasons, active funds also need to show they’re not duplicating holdings that can be replicated passively (and often at a lower cost) through an ETF or index fund. With the concentration around a small number of stocks that inevitably occurs with an index fund, investment risk can actually increase, something that needs to be considered by investors when weighing up actively versus passively managed funds.
Whilst a commitment to adding alpha by out-performing the index is a big draw card of an actively managed fund, their value proposition has to deliver more than outperformance, also demonstrating that using the fund in a portfolio enhances the risk/reward characteristics of the total portfolio and complementarity with other investment vehicles being used.