February 2021

Active fund managers outshone passive equivalents during 2020. Here, we look at the pros and cons of active and passive investing and explain why a well-diversified investment portfolio should contain elements of both.

The reputation of the active fund management industry has taken a bit of a pasting in recent years, although active fund managers fought back strongly in 2020. According to research carried out by Quilter, active funds outperformed their respective markets in seven out of the ten major investment sectors, including the UK Smaller Companies and UK All Companies sectors, as well as the indices for Japan, Emerging Market Equities and Global Equities.

What are ‘active funds’?

As a quick reminder, ‘active fund management’ is when a fund manager, or a fund management team, is in control over the investment and takes responsibility for the performance of the portfolio overall. Active funds usually aim to outperform a benchmark such as the FTSE All Share Index and will build a portfolio comprising those companies it thinks are worth holding.

Active fund management is all about decision-making. We are talking about real human beings, making real-time investment assessments, and changing their portfolios accordingly. Active fund management, as the name suggests, is a full-time, 24-7 job. And it is expensive, with all those costs reflected in the charges that investors can expect to pay in management fees. Therefore, it comes as no surprise that active fund managers face heavy criticism when they fail to outperform their benchmarks. Because even with the best available fund managers, there is no guarantee that the fund itself will deliver a better return.

And what about ‘passive funds’?

As the name also suggests, a passive fund does not have a decision-maker at the helm. Instead, passive funds usually aim to match the performance of an index or a particular sector of the market. The most common types of passive funds are index trackers or exchange traded funds (ETFs). In the case of a FTSE All Share tracker, for example, the fund will hold shares in every single company listed in that index, and its performance will fall or rise in line with the entire market.

Because there are no fund manager salaries to pay, and no research or trading expenses, it means that passives are much cheaper to invest in over the long term. Furthermore, you are achieving the same level of performance as the index, which is great news when markets are in positive territory, but less welcome when markets are experiencing periods of heavy volatility.

Active managers responded well to coronavirus

That is precisely what happened in 2020. In the early weeks of the coronavirus pandemic, stock markets across the world fell dramatically, as the potential implications of extended lockdown started to be felt. But over the course of the year, it soon became clear that the pandemic would lead to some companies emerging as ‘winners’ and other less-fortunate companies would be ‘losers’. This resulted in a sharp recovery in equity markets, with tech companies doing particularly well.

Successful active managers were able to react to the stock market falls and move their portfolios away from owning those stocks less likely to do well during lockdown, and at the same time increase their investments in those companies capable of making big profits – in some instances buying them up at bargain prices. Passive funds, on the other hand, had no such opportunity. In a market sell-off, passive funds will simply follow the market lower, unable to get rid of those unfortunate ‘losers’ that are dragging overall returns down.

So, which is better?

Of course, one poor year doesn’t make passive funds a bad investment, just as one good year doesn’t necessarily mean you should only own active funds from now on. At FAS, we believe well-diversified investment portfolios should feature a blend of both active and passive funds. But it’s important to look for those funds that offer value for money.

For example, passive investments offer the potential for better returns when shares are generally moving together in the same direction. So, they can be used as a cost-effective way to gain broad investment exposure to particular markets, acting as essential long-term building blocks in a portfolio.

However, sometimes the stock-picking skills of an experienced and well-researched fund manager can give the fund a definite edge over its competitors – helping to generate valuable risk-adjusted returns. Plus, the ability for these fund managers to adapt to changing events and swiftly ‘change course’ can prove invaluable during periods of market turbulence. In these instances, additional returns achieved by the best fund managers can more than justify the fees they charge.

Conclusion

Low-cost investments might seem like a sensible choice, but good investments are usually worth paying that bit extra for. The good news is that you do not need to make a choice between active or passive funds, and we can help you to decide on the best way to capture the benefits of both within your portfolio.

If you think now might be a good time to review your investment holdings, and to take a more ‘blended’ approach, please get in touch with one of our advisers who’d be happy to discuss some investment options with you.

If you are interested in discussing your investment portfolio with one of our experienced financial planners at FAS, please get in touch here.

This content is for information purposes only. It does not constitute investment advice or financial advice.

With countries all over the world determined to recover from the pandemic, infrastructure looks likely to be a prominent investment theme over the next few years. We look at some of the biggest areas of infrastructure investing and assess the positives and negatives for investors.

The building of bridges, railways, and motorways are all examples of high-profile infrastructure developments, while schools, prisons, and hospitals are all just as essential to a functioning society, and the demand for infrastructure spending may well increase as a result of Coronavirus. Governments in developed markets, including the UK and the US, have promised to “build back better”, and see infrastructure projects as a way to create more jobs and boost long-term economic growth. As a result of this, we can expect more announcements of projects that move away from ‘traditional’ concepts of infrastructure, and towards next-generation projects, such as smart motorways and intercity transit, 5G base stations and renewable energy installations, and electric vehicle charging points.

Infrastructure as an investment

It’s no surprise then, that there has been growing interest from investors who see infrastructure as an excellent long-term investment opportunity. But there are other benefits too. Just like property, infrastructure is a tangible asset to hold, which makes it altogether easier to understand, and therefore easier to invest in.

It is also worth noting that the infrastructure sector has also proven to be a reliable source of investment returns. Again, the tangible nature of infrastructure means it can provide investors with a predictable and regular stream of cashflows over several years – often linked to inflation. And, because infrastructure projects are backed by government public sector spending, the project risk is usually shared.

Investments that offer a reliable repeatable cashflow are very appealing, but many investors are only starting to recognise the role that infrastructure investments could play as part of a diversified mix of portfolio investments.

Within the investment universe, infrastructure is considered as part of the ‘alternatives’ sector, sitting alongside property investment, renewable energy, bonds, debt, and specialist finance, as well as the less accessible but well-established areas of private equity and hedge funds. All of these are considered ‘alternative’, as they are expected to produce returns with very little in common with the returns available from equity investments. Because of this, a ‘diversified’ portfolio is likely to feature an allocation towards alternatives that aim to achieve returns in periods when equity markets perform less strongly.

A move away from traditional investments

Alternatives have surged in popularity as more investors (of all shapes and sizes) have grown frustrated with the old-fashioned ‘balanced’ model of investing, where the belief is that holding both higher return/higher-risk equities and lower return/lower-risk investments in bonds effectively gives investors lower volatility and smoother returns throughout the investment journey – regardless of any stock market ups and downs.

The biggest problem with that approach is that with government bond yields stuck at historic lows, bonds are offering little or no return for investors, and are therefore not really justifying their place within portfolios. So, at a time when we are all questioning the old ways of doing things, it might be time to rethink those traditional labels of ‘mainstream’ and ‘alternatives’. Infrastructure could then be viewed as overtaking bonds as an asset class capable of providing useful portfolio diversification – with little correlation to riskier equities, but capable of providing inflation-linked returns and a steady stream of positive income.

Infrastructure trends to think about

So, if you are considering investing in infrastructure, are there any specific areas worth focusing on? You might want to start with infrastructure investments that focus on renewable energy. Back in 2015, 193 countries signed up to the United Nations General Assembly’s Sustainable Development Goals (SDGs). If governments across the globe are serious about achieving some or all of these goals, they will need to implement infrastructure spending covering areas such as solar and wind projects designed to help accelerate the transition towards a low-carbon future.

Digital infrastructure

Another fast-growing area involves digital infrastructure. If 2020 has taught us anything, it is that people have become increasingly dependent on digital access. Working remotely, shopping through e-commerce, and spending more of our leisure time at home (and in front of our computer or TV screens) has accelerated the global demand for fibre-optic networks, telecommunication towers, and data centres.

You may think that internet activity – whether that means using emails or streaming films on Netflix – is these days mostly carried out ‘in the cloud’. But data centres are the buildings used to house computer systems, servers, and storage. These data centres and exchanges rely on a largely unseen network that requires millions of miles of fibreoptic cable, cellular base stations, towers, and countless signal transmitters. Demand for data centres and associated components has increased dramatically over the last 12 months, and this demand only looks like increasing in the future.

How to invest in infrastructure

As an asset class, infrastructure used to be the preserve of big money institutional investors. But today there is a range of different investment vehicles that offer infrastructure exposure to individual UK investors, either in the form of open-ended funds or investment trusts. Investment trusts tend to own the physical assets (such as wind turbines, data centres, or toll roads), whereas open-ended funds invest in the equities of the companies that operate in these sectors. These include the major engineering and construction firms that are contracted to plan and deliver on large infrastructure projects, as well as companies that supply the tools and equipment.

As a result, we expect the number of funds – focusing on all different aspects of infrastructure – to increase from here. But as with any type of investment, it is important to understand the structure of the investment (particularly whether it is an investment trust or an open-ended investment), where it expects returns to come from, and to determine whether the risk is appropriate for the available reward. We would also argue that now infrastructure investing is becoming more fashionable, it is even more important to choose those investments managed by companies with a good track record, who manage risks appropriately, and who do not promise returns that are too good to be true.

Outlook

The coronavirus pandemic may well present an opportunity to “build back better”, and to replace old ways of living with new ones. As a result, infrastructure looks like becoming an important investment trend for years to come, and we expect it to play an increasingly prominent role within investment portfolios.

If you are interested in discussing your financial plan or investment strategy with one of our experienced financial planners at FAS, please get in touch here.

This content is for information purposes only. It does not constitute investment advice or financial advice.