A long-running investment debate concerns whether to invest in index-tracking funds (traditional index funds and exchange traded funds) or actively-managed funds. Unfortunately, it is frequently conducted as an ‘either-or’ debate.
Yet investors who clearly recognise the powerful case for index funds often still find a place in their carefully-constructed portfolios for some favoured actively-managed funds.
At Vanguard, for instance, it is not a case of having index or active management to the exclusion of the other.
Vanguard has just released an updated version of a key research report, The case for index fund investing in Australia. Its findings reinforce why investors are increasing choosing to invest at least the core of their portfolios in index funds – even though many will decide to hold smaller satellites of actively-managed funds.
The research demonstrates that:
After costs, the average actively-managed fund underperformed various benchmarks in most asset classes over the short and long term, and through varying market environments.
Reported performance statistics for actively-managed funds can "deteriorate markedly" once no-longer-surviving funds are included in the figures. (Funds that don’t survive typically merge with other funds or close due to poor performance.)
Low-cost index funds have displayed a greater probability of outperforming higher-cost, actively-managed managed funds. This is despite the expectation that index funds are expected to under-perform their benchmarks by a small margin once costs are taken into account.
The persistence of performance among past high-performing funds is "highly random".
The research was based on the short to long-term performance to December 2014 of actively-managed funds available to Australian investors, focusing on Australian and international equities, Australian listed property and Australian and global fixed interest.
Significantly, the researchers emphasise why investors should place a high priority on minimising their investment management costs. "For investors, the clear implication is that by focusing on low-cost funds – both active and passive – the probability of outperforming high-cost portfolios increased."
Further, the researchers highlight the other benefits of index investing. "First and foremost, index strategies benchmarked to a broad market indexes can provide greater control over risk exposures in a portfolio," they write.
Other potential advantages of index funds include wider diversification when tracking broad indexes, style consistency and tax-effectiveness from lower turnovers of assets.
Of course, one of the toughest jobs for an investor wanting to invest in actively-managed funds is trying to select those that they expect to outperform their benchmarks in the future – given that out-performance is their aim.
This research found that consistent out-performance by any one active manager has been rare. "The challenge facing investors [in active funds] is to correctly identify those managers who they believe may outperform in advance and stick with them through good and bad." It’s a tough call.
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Robin Bowerman is Head of Market Strategy and Communication, Vanguard Australia. As a renowned market commentator and editor Robin has spent more than two decades writing about all things investment. |
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