Charting a passive course through stormy waters

When it finally came, the end of the bull market didn’t pan out anything like the active fund industry predicted it would.

First, active managers failed to provide the “downside protection” protection we were promised. In fact, far from cushioning investors from the full extent of market falls, active funds in exacerbated them.

Yes, there were exceptions, as there always are. From the start of 2020 to the end of March, for example, Fundsmith Equity declined 7.9%, compared to 15.7% for the MSCI World index. But overall, active fund performance was poor. According to data from SCM Direct, the average fund fell 2.1% further than the index over the same period.

A second prediction that proved wildly inaccurate was that passive investors would head for the hills en masse at the first sign of serious volatility. In the event, not only did most passive investors resist the urge to sell, but they also calmly carried on buying while markets went down.

Thirdly and finally, we haven’t seen the flight from passive to active funds that many said we would. Of course, we’ve been bombarded with the same old messages about active managers coming into their own at times of acute uncertainty, but they’ve mostly fallen on deaf ears. Figures from Calastone show that active funds saw outflows of £1.7 billion in March, while passive funds saw inflows of £1.7bn.

No escape for indexers

Of course, this is not to say that the recent market rout was kind to passive investors either. No market downturn is. The FTSE All-Share index was especially badly hit, falling 25.3% in the first quarter of 2020.

But, once again, diversification proved to be the best defence against falling prices. The MSCI Europe index, for example, fell 19%, the S&P 500 in the United States fell 14%, and MSCI Japan a relatively modest 11.6%.

Mass diversification through index funds doesn’t protect you from market risk, but it does shield you from the concentration risk that is part and parcel of active investing. Even when the economic outlook is as grim as it is now, there will always be asset classes, sectors and countries that perform relatively well.

As ever at times like these, you’ll find plenty of tips in the media on where the richer pickings will be. The truth is, no one knows.

Pay less, keep more

The most logical choice, regardless of the market environment, is a globally diversified fund that includes both stocks and bonds.

Vanguard LifeStrategy 60, for example, which was down 10.43% in Q1, has returned 25.19% over the last five years. The more adventurous LifeStrategy 80 was down 14.28% in Q1, but over five years is up 27.67%.

Where markets are headed over the next five years is anyone’s guess. But at least, with an index fund, you are guaranteed to receive, near enough, the market return — and you’ll also save yourself a tidy sum in fees.

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