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Mitchell Fraser-Jones 3 June 2014 Est. reading: 4 min read

Why should I pay for active fund management when passive is so much cheaper?

We believe the market is inefficient – if we didn’t believe this there would be no need for active fund management. As active investors, we believe we can exploit the market’s inefficiencies to add value by outperforming the market (and, therefore, passive funds which track the market) in the long run.

The main reason the active versus passive debate gets air time is because many active fund managers do not add value – they destroy value by underperforming. Market performance is, in essence, an average of all outperforming funds and all underperforming funds.

The main advantage of a passive strategy is its lower fee structure which allows investors to cheaply avoid the risk of choosing the wrong active fund manager. We are working hard to keep our costs low but we cannot possibly compete with the ultra-low fee structures of passive funds.

But proven active fund management comes into its own in periods when the market environment as a whole is more challenging. In periods when the market is moving sideways or in decline, an appropriate active fund management strategy can continue to deliver positive returns.

Actively managed funds can buck the trend of a falling market, whereas passive funds are locked into the downward trend. The post-bubble experience of 2000-01 is a great example of this – the market was embarking on a protracted decline as the bubble deflated, but some fund managers, Neil Woodford included, were able to continue to deliver positive returns by avoiding the over-valued shares that were at the heart of the market’s slide and focusing their portfolios towards the under-valued parts of the market that had been shunned while the bubble was inflating. This was a period when talented active fund managers with a disciplined approach and a sensible, valuation-focused strategy, were able to really demonstrate the value they can add.

The past five years have told a very different story, however. The market has been difficult to beat – in other words, it has been much harder for active fund managers to add value through outperformance even though many have delivered attractively positive returns.

But rather than question whether paying more for an active fund manager is sensible or not, we believe it is more sensible to try to understand why the market has been difficult to beat over the last five years, and whether these reasons will continue to influence markets over the next five years and more.

In our view, the primary market driver over the last five years has been the extraordinary monetary policy that has been in place throughout this period in the form of Quantitative Easing (QE). QE was designed to lift asset prices and, in this regard, it has worked. But it has not been discriminate – the tide of QE has lifted all ships. All shares have benefited, not equally, but correlations between stocks have been much lower over the last five years than is usually the case. It should not be a surprise, therefore, that this has been a difficult period for active fund managers, particularly those with a fundamental, long term approach, to outperform an artificially buoyant market.

The question is, therefore, is QE going to have the same effect over the next five years? Very unlikely, in our view. It is already being withdrawn in the US, primarily because central bankers have become considerably more concerned about the unintended consequences of the policy, including the risk of inflating new asset price bubbles. The tide of QE is now going out again and, as Warren Buffett once said, “you only find out who is swimming naked when the tide goes out.”

To conclude, there are some periods in equity markets when passive strategies perform well and others when active fund managers thrive. Looking through these cycles, successful active fund managers have proven they can add value by focusing on and delivering attractive long term positive returns, particularly in more challenging market conditions. We believe the market is transitioning from a period which has been benign for passive strategies, to one in which active fund managers with a sensible, proven investment approach and an appropriate strategy, can add significant value.


This article forms part of our Your Questions Answered series. If you haven’t already done so, we would encourage you to subscribe to our blog using the “Subscribe to articles” link above, to be alerted when a new post is added. If you would like to pose a question, please leave a comment below.

What are the risks?

  • The value of the fund and any income from it may go down as well as up, so you may get back less than you invested
  • Past performance cannot be relied upon as a guide to future performance
  • The ongoing charges figure is charged to capital, so the income of the fund may be higher but capital growth may be restricted or capital may be eroded
  • The fund may invest in other transferable securities, money market instruments, warrants, collective investment schemes and deposits – some of these security types could increase the fund′s volatility and increase the level of indirect charges to which the fund is exposed
  • The fund may invest in overseas securities and be exposed to currencies other than pound sterling – as a result, exchange rate movements may cause the sterling value of investments to decrease or increase
  • The fund may invest in unquoted securities, which may be less liquid and more difficult to value, because they are generally not publicly traded – the lack of an open market may also make it more difficult to establish fair value

Important information

Before investing, you should read the Key Investor Information Document (KIID) for the fund, and the Prospectus which, along with our terms and conditions, can be obtained from the downloads page or from our registered office. If you have a financial adviser, you should seek their advice before investing. Woodford Investment Management Ltd is not authorised to provide investment advice.

The Woodford Funds (Ireland) ICAV (the “Fund”) has appointed as Swiss Representative Oligo Swiss Fund Services SA, Av. Villamont 17, 1005 Lausanne, Switzerland. The Fund′s Swiss paying agent is Neue Helvetische Bank AG. All fund documentation including, Prospectus, Key Investor Information Documents, Instrument of Incorporation and financial reports may be obtained free of charge from the Swiss Representative in Lausanne. The place of performance and jurisdiction for all shares distributed in or from Switzerland is at the registered office of the Swiss Representative. Fund prices can be found at www.fundinfo.com.

Woodford Investment Management Ltd is authorised and regulated by the Financial Conduct Authority (firm reference number 745433). Incorporated in England and Wales, company number 10118169. Registered address 9400 Garsington Road, Oxford OX4 2HN.

Woodford Patient Capital Trust plc is incorporated in England and Wales, company number 09405653. Registered as an investment company under section 833 of the Companies Act 2006. Registered address Beaufort House, 51 New North Road, Exeter, EX4 4EP.

© 2019 Woodford Investment Management Ltd.
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