Index tracker funds beat managed funds... sometimes


Updated on 16 July 2014 | 1 Comment

Two new pieces of research highlight the fact that the passive versus active investing debate isn't a straightforward one.

Low-cost index tracker funds conclusively outperform higher-cost managed funds, according to new research by fund provider Vanguard.

In the latest round of the perennial passive versus active investing debate, Vanguard says low-cost index trackers outperformed managed funds in nine out of 11 broad investment categories.

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The fund-amental difference

We’ve always been big fans of index tracker funds here at lovemoney.com. These funds track specific indices, for example the FTSE100, and the companies listed on them in a direct attempt to replicate their performance. As there is very little human intervention involved, they have very low costs. if you invest regularly, and for the long term, you’ll hopefully ride out the peaks and troughs.

Having said that, a good fund manager can beat the market by careful stockpicking. But, understandably, there’s a price to pay for this active approach. And many fund managers underperform their benchmarks. This is in part, Vanguard says, due to their high fees, which eat into investors’ returns.

Vanguard looked at investor returns over a 10-year period on a broad range of both low- and high-cost funds (so passive trackers versus active fund managers). Here are six examples of equity funds from around the globe.

Sector

Low-cost median returns

High-cost median returns

Difference

Global equity

8.36%

7.16%

1.20%

UK equity

8.79%

8.20%

0.59%

European equity

8.35%

8.71%

-0.36%

Eurozone equity

7.79%

7.19%

0.59%

US equity

7.72%

6.31%

1.41%

Emerging market equity

12.33%

9.20%

3.13%

Source: Vanguard

A reasonably compelling case for passive investing in trackers then, although returns from European equity funds were greater from managed funds.

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Is it that simple?

However, recent research by investment platform rplan found that the passive versus active debate actually comes down to markets and sectors. In other words, managed funds outperform index trackers in certain areas.

In fact, the rplan research mirrors Vanguard’s in that managed funds outperformed index trackers across European funds, albeit over five years in this instance.

It also found that index trackers are more likely to produce greater returns in markets such as the US. However, looking at the likes of China and Japan, managed funds consistently outperformed index trackers.

Sector

Chance of picking a managed fund which outperformed an index tracker

Europe

100%

China

100%

Emerging markets

88%

Japan

83%

UK

71%

US

45%

Source: rplan

Indeed, rplan says that the more different a market is to our own, and therefore the scarcer the information coming out of it, then the greater the need for expert knowledge via an active manager.

For me, this doesn’t quite ring true in terms of Europe, where there is plenty of information to aid investors, albeit the markets are different to our own.

Another, arguably more important factor rplan highlights is that index trackers in countries such as China are tracking major indices that are more geared towards certain sectors such as financials. So if a major event happens that affects most, if not all, of that sector, and therefore the index, the tracker will be dragged down too. However, an active manager can try to mitigate those losses by selling and buying into something else.

Ultimately though, it’s up to you and your attitude to investing. If you want lower costs and not to have to spend time researching investments, then trackers are the better option.

However, if you want your money to beat the market, you’ll have to take on more risk, more research and more cost. But you need to make sure you pick carefully.

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More on investing:

Beginner's guide to stocks & shares ISAs

Beginner's guide to index tracker funds

Beginner's guide to managed funds

Beginner's guide to investment trusts

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