Seeking Alpha

Active Funds: Coming Out Of The Blocks Slowly In 2018

by: Lipper Alpha Insight

By Jake Moeller

Having recently enjoyed a feast of inspiring Commonwealth Games performances, I was prompted to check out how well active funds have come out of the blocks in 2018.

I'm on the record as saying 2018 could be a good year for active funds. Typically, late-cycle environments precede a rotation out of momentum-based ETFs and the increasingly expensive large-cap stocks they invest in, providing fertile ground for active stock pickers.

No signs of passive vehicle flow slow down in 2018

There is no doubt that flows into passive funds in Europe and the U.K. have been buoyant over the last few years, with some evidence of reaching "peak passive" at the end of 2017. Thomson Reuters Lipper data reveal that the average annual percentage of passive pan-European fund (ETFs and tracker funds) flows of total fund flows was 5% from 2004 to 2014.

Exhibit 1. Historical European Estimated Net Fund Flows by Product Type (€bn)

Source: Thomson Reuters Lipper

For 2015, passive vehicles had a huge year, constituting 32% of total fund inflows. For 2016, this figure fell to 24%, and for 2017, the figure was 11%. However, for Q1 2018, the provisional figure rose to over 30%, suggesting the love affair with passive funds is far from over in Europe.

The majority of active funds are performing below passives

Performance-wise, Q1 saw passive vehicles take an early and commanding lead. Only about 7% of active funds in the Lipper UK Equity classification beat the highest-ranked broad-based tracker over the period. In the Lipper Europe ex UK classification, the figure was higher, with 47% of active funds beating the highest-ranked broad-based tracker fund. For the Lipper US Equity classification, the figure was 34%.

The "opportunity cost" of passive investing can still be considerable

When it comes to performance comparisons, it is important to consider the "opportunity cost" of not investing in an active fund (i.e., the potential outperformance of an index). Often, this can be considerable. For example, for the five years to the end of 2017, the best-performing active fund in the IA UK All Companies classification outperformed the highest-ranking broad-based tracker by around 85 points - not inconsiderable. For Q1 2018, the comparable spread over the period was around 4 points. Again, for the period that was not insubstantial.

Fund investing is a marathon, not a sprint...

Of course, one needs to have correctly identified these winning funds in advance of the performance outcomes. Whilst I still believe that over the longer term, persistency of alpha generation can be found (consider, nearly 75% of the Lipper Fund Award trophy winners of 2014 were in the first or second quartile of their sectors for three-year performance at the end of 2017), over Q1 2018 random selection would have certainly favoured a passive option.

On the face of it, Q1 was fairly nondescript for active funds. Fund flows and performance were firmly in favour of passive. However, fund investing is a marathon, not a sprint - and my faith in active funds to climb back up the gold medal tally by year end remains.

Disclaimer: This material is provided for as market commentary and for educational purposes only and does not constitute investment research or advice. Thomson Reuters cannot be held responsible for any direct or incidental loss resulting from applying any of the information provided in this publication or from any other source mentioned. Please consult with a qualified professional for financial advice.