Debate on investment strategies reactivated

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The Independent Online
John Bridgeman's swipe at the pensions industry has re-opened a heated debate in the City over the relative merits of traditional active fund management and the so-called tracker or index funds that limit their ambitions to matching a market benchmark such as the FTSE 100 index, writes Tom Stevenson.

The argument has been highlighted recently by several high profile and costly misreadings of the stock market by well-known fund managers and a steady encroachment by passive funds which now account for about a third of all assets under management in the US and a growing proportion of British pension funds.

Best known of the active managers who have got it expensively wrong has been Tony Dye at PDFM, whose move out of shares and into cash in anticipation of a market crash has meant his clients have missed out on the late stages of one the most prolonged bull markets ever. He has crashed down the league tables of the City's highly paid fund managers and suffered a damaging blow to his reputation.

By contrast fund managers such as Barclays Global Investors, the asset management arm of the high street bank, are enjoying strong demand for their low cost, predictable service. BGI claims to be the biggest fund manager in the world with pounds 225bn of funds under management.

According to James Woodlock, managing director of BGI: "The advantages are low cost and certainty. I wouldn't like to count how many active fund managers I've put out of business over the last 10 years."

He said active funds charged between three and four times as much in annual management fees on a typical pension fund as their passive rivals.

The passive fund managers, backed yesterday by Mr Bridgeman, claim that in the long run it is impossible for active managers to consistently outperform the market by share picking. WM Company, the performance measurement specialist, provides statistical evidence to back that claim.

According to WM, a study of more than pounds 200bn of pension funds showed that between 1986 and 1995 actively managed funds returned 14.7 per cent a year compared to 15.1 per cent from passive funds. The All Share index during that period averaged 15.2 per cent a year.

According to WM's Alastair McDougall: "There will always be active funds that do spectacularly well but there will always be funds that do particularly badly. The whole point about the index approach is that it gives you a defined return relative to a given index."

Index-linked portfolios, many of which only change as the underlying index does, have far less turnover than active portfolios, with turnover in all index-type funds about 15 percent annually, according to WM Company. This compares to turnover of between 50-80 per cent in active portfolios.

Active managers hotly dispute the claims of their passive rivals, with a spokesman for Mercury Asset Management saying yesterday: "The average actively managed fund does tend to outperform but the best can be expected to substantially outperform over time."

Steven Cameron, director of pensions development at Scottish Equitable agreed: "Its a sweeping generalisation. I'm surprised at the Office for Fair Trading suggesting that we limit consumer choice."

Julian Samways, head of marketing at Schroder Investment Management, added: "There is evidence that a proportion of active managers do consistently outperform indices."

He cautioned that an over-reliance on index funds can lead to distortions in the market, as the proportion of freely traded shares diminishes.

``You could get a situation where the guy with the one freely traded share of Boots is able to move the market."

Currently, most British pension funds use active managers for their equity portfolios, with only around 15 per cent in passive funds. A wholesale move to index trackers along the American lines could mean substantial job losses in the fund management industry.