Passive investment wins on most fronts: Tracking indices by computer reaps rewards, writes Iain Jenkins

Click to follow
EARLY next year shoppers in Marks and Spencer will be able to buy a pension along with their prawn sandwiches and underwear.

The chances are that much of the money put into an M&S pension will follow the strategy of M&S unit trusts and be invested 'passively' in funds that use computers to track an index, such as the FT-SE All Share Index.

In recent years 'passive' investment has taken the pensions industry by storm. The professionals increasingly see it as offering a more reliable performance than active fund managers. Furthermore, tracking an index is cheaper.

M&S is a convert. Since 1988 it has been selling unit trusts through its stores and 36 per cent of its Investment Portfolio fund is indexed, while 40 per cent of its UK Selection Portfolio is in passive holdings.

David Towel, executive director of M&S financial services, says: 'When a customer buys an investment or savings products from us, they are buying comfort in the name of M&S. We have decided that it won't do our portfolios any harm to have a big weighting in indexation.'

Yet, only about pounds 700m of private investor money is in index funds in the UK compared with pounds 80bn in active management. So why, if M&S and the pension industry have seen the value of index funds, hasn't the small investor?

The answer is partly that tracking the index is seen as boring. For many the lure of a unit trust is the upside. With luck and good judgement investors in actively managed funds can see spectacular gains.

But there is another reason as Richard Bolchover, director of John Govett, explains: 'Without being too cynical, it is not in the interest of investment advisers to push index funds that offer lower margins and will do them out of a job.'

Unit trust groups are falling over themselves to tell investors that they are cutting initial charges. But few are telling investors that the management fees on index funds are normally around 0.5 per cent compared with 1.5 per cent for 'actively' managed funds. Furthermore, since May 1992, investors have been able to buy into Gartmore's UK index fund without any initial charge.

But if the cost argument in favour of indexation is not persuasive, then maybe the performance figures will be. 'The figures show that the indices relentlessly perform better than three quarters of all fund managers,' says Nigel Legge, the head of unit trust management at James Capel, the retail market leader for index funds.

According to Micropal figures that compare the performance of 117 unit trusts with the FT All Share index over a six-year period, the index came in its habitual place in the top quartile in 1988 and 1989. Then in the next four years the index slipped into the second quartile and came 38th, 37th, 61st and 62nd due to the strong run by small and medium-sized companies.

A poor performance? No. When the figures are averaged out over the six-year period the index came in 14th place. This means that the fund managers have been erratic. Most private investors would be very happy with the return offered by the index.

'There is always going to be a manager who will beat the index. The question is: can you - as the small investor - pick the manager every time? The chances are that you can't. So, if you want to be able to sleep at night you may be better off picking the index,' says Tony Fraher, chief executive of Singer & Friedlander's unit trust company.

Can it be long before the private investor tires of paying heavy fees to a fund manager who cannot even beat the index consistently?

(Photograph omitted)

Looking for credit card or current account deals? Search here