The active versus passive management debate has again come into focus following the recent release of various research reports on the topic. The results both across and within asset classes were mixed, suggesting that the ‘active/passive debate’ ultimately comes down to manager selection and personal preference, according to BRETT HIMBURY, the managing director of Tyndall Investment Management. While it is inevitable that some active managers will underperform their respective indices at points in time, a significant proportion also outperform. A point that seems to be overlooked is that, while comparing a fund to the index is the most common measurement to use in the active/passive debate (as I have done in this article, to be consistent with recent publicly available research), in reality this is not comparing like with like, nor is it the real ‘investor experience’. An index is a theoretical measure, which an investor can’t actually invest in and isn’t representative of a typical managed fund.

For instance, an index return doesn’t have fees, incur transaction costs or experience cashflows, and it rebalances at closing prices. All of these factors impact returns in the real world. So comparing an active fund’s returns with the index is essentially comparing a real investment opportunity with a theoretical one. A more accurate measure is to compare the returns of active funds with those of passive funds. As a guide to the difference this can make, one of the most popular flagship passive funds in the Australian equities market returned 0.18 per cent per annum below its benchmark on an after-fee basis since its inception (12 years to 30 June 2009). Compare this with the Tyndall Australian Share Wholesale Portfolio. As at 30 June 2009, the Fund outperformed its benchmark, the S&P/ASX 200 Accumulation Index (after fees), over one, three, five, seven, 10 years and since its inception (March 1995), as shown in chart 1.

In dollar terms, a $10,000 investment in the Fund in March 1995 would have been worth $43,195 (after fees) in June 2009, compared with a theoretical $36,000 if invested in the Index. This difference of $7195 over a 14-year period is a significant amount for an investor, and one example of the benefits an active fund manager can provide over an index manager. Indi vidua l st ocks At Tyndall, we have undertaken our own research into the performance of individual stocks in the S&P/ASX 200 Index from 2001 to 2008, which has provided some interesting insights on the active/passive debate. Over the eight-year period that we studied, there were five years where more than 30 percent of stocks delivered negative returns (as shown in chart 2) – even in the good years for the market. In 2007, for example, when the market returned a healthy 16 percent per annum, 40 percent of stocks in the Index showed a negative return. There were also some wide variations in performance. The worst performing stock (Centro Properties) fell close to 90 percent that year. In comparison, the best performing stock (Incitec Pivot) rose a phenomenal 245 percent.

That’s a marked difference in performance and such variations can have a significant impact on performance if held in a portfolio. If investing with a passive manager, investors will have exposure to the poor-performing stocks as well as the strong-performing stocks. This is where the value of an active manager can really come to the fore. By virtue of the fact that they seek to outperform the Index, they are not forced to hold all of the stocks in the Index (this of course also has the trade-off of a higher tracking error). This can be particularly beneficial during a down market, as active fund managers can make a call not to hold poor-performing stocks, whereas passive managers are required to own all of the stocks. The value of bottom-up research really comes into play and highlights how important it is to pick the right manager. Tyndall is a strong believer in active management for both Australian equities and fixed income funds.

We believe there are inefficiencies in the market which can be exploited by those that can pick quality stocks that represent good value. Within the fixed interest area, credit investments highlight the need for active management. With credit’s asymmetric return profile, active management reduces tail risk by excluding those parts of the benchmark most likely to underperform severely – avoiding one default or serious downgrade of a benchmark component can give rise to substantial outperformance. More generally, an active selective choice of a diversified portfolio of credits can optimise returns while reducing risk. One point that both active and passive managers can generally agree on is that there is a place for both in the investment management industry – passive managers can’t function well without the analysis carried out by active managers, while active managers rely on beta to provide mispricing opportunities.

While the individual investor might have a philosophical belief about active or passive, ultimately it comes down to selecting the right manager. A proven and disciplined investment process, consistent performance, a well-resourced and stable investment team and a strong business framework are key factors investors need to focus on – rather than relying on surveys that paint a particular picture about one style versus the other at one point in time. Indeed our own research on the performance of both our Australian equities and fixed interest capabilities proves the point. Certainly we haven’t outperformed every year and no manager has, but on average, over the long term on an after-fees basis, we have. Brett Himbury is the managing director of Tyndall/Suncorp Investment Management

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