Why you shouldn’t invest with active fund managers (most of the time)

In the investment world there has been a long running debate about which is best for investors – active or passive fund managers. For those of you out there who do not know the difference let me explain.
 
Active fund managers as the name implies actively invest using their own research and judgement to buy shares which they hope will outperform an index such as the FTSE100 Share Index. They invest more money in research, they employ more staff and they tend to buy and sell more shares than passive fund managers so their expenses tend to be higher.
 
Passive fund managers on the other hand invest in the shares which make up an index such as the FTSE100 and make no attempt to outperform it. They conduct no research and they occasionally buy and sell shares when certain companies enter and exit the index from time to time. So basically they mirror the index.
 
An index is simply a basket of shares or other assets. In the case of the FTSE100 it happens to consist of the 100 largest publicly quoted shares on the London Stock Exchange. However there are literally hundreds if not thousands of alternative indices such as UK Smaller Companies, US equities, European Properties, Gold, Oil etc. You name it, there will be an index for it!
 
The good news is that some active fund managers beat their benchmark indices. The bad news is most fail to do so. What’s more the main reason for the underperformance is, you guessed it, the higher charges!
 
There has been much independent research on passive vs. active fund management. One of the best sources of research on the subject I have ever studied is Tim Hale’s excellent book Smarter Investing. It’s pretty convincing that passive investment funds beat active investment funds the majority of the time and that for most investors passive funds are the best solution.
 
This was one of the main reasons why our sister company Wealth And Tax Management chose the Parmenion Wrap account as the investment solution for its clients because it is a discretionary fund management strategy based on passive funds. Not only has this resulted in lower charges for our clients but surprise, surprise better investment performance too.
 
We launched our first fund, The Intelligent Wealth Fund, on 16 April. Whilst this will is an active fund it will retain the best elements of a passive fund such as lower charges than other active funds, a predominantly buy and hold approach rather than lots of share dealing and a niche strategy based on 8 futuristic mainly technology themes.
 
Because our 3 year back tested returns have been so good we are confident our fund will be one of the few that consistently outperforms passive funds. It’s for this reason that Wealth And Tax Management intends to include it in its investment process as the satellite element of a core satellite strategy. Parmenion will continue to be the core (80%) element of the investment strategy investing in passive funds with The Intelligent Wealth Fund providing the balance (20%) in an active fund.
 
A core satellite strategy is becoming increasingly popular with financial advisers because it combines the best elements of both passive and active funds. The adviser can invest the core (80%) in a range of low cost, conservative, predictable funds with the balance (20%), the satellite. Invested in higher risk/higher return funds to hopefully achieve an overall return better than, say, the MSCI World Index.
 
It’s a bit like cooking. The core ingredients make up the basic meal but the satellite consisting of the herbs and spices really give it the flavour, give it that extra taste. In many ways that is what a core satellite investment strategy seeks to achieve.
 
So if you are a financial adviser who favours a core satellite strategy and is wondering which fund or funds to invest in to achieve a higher return you could do far worse than invest in the CCM Intelligent Wealth Fund. You know it makes sense.