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Is there a bubble in passive funds?

For some time now there has been a growing number of people voicing concerns that there is a bubble in passive funds. It is a growing debate about which even the experts do not agree. So nothing new there then!

Nonetheless, it is an interesting argument because passive funds, otherwise known as index-tracker funds, have become very popular in recent years. So what is the difference between passive funds and active funds?

Well, a passive fund merely replicates the constituents of an index such as the FTSE100 Share Index. The manager invests in the same 100 companies that make up the index and doesn’t conduct any research. So the costs are low which is reflected in a lower annual management charge.

An active fund, on the other hand, employs fund researchers to research shares and, hopefully, chooses stocks that will outperform the index. Unfortunately only about a third of active funds outperform index tracker funds hence the reason why the latter have become more popular in recent years resulting in increasingly larger sums of money going into passive funds.

This is why some people such as Michael Burry, the fund manager of Scion Asset Management (https://scionasset.com) who became famous for shorting mortgage-backed securities before the 2008 global financial crisis in the film The Big Short (https://en.wikipedia.org/wiki/The_Big_Short_film), considers there is a bubble in index-tracker funds. His argument is that such funds’ automated buying of large stocks means that smaller, value-type shares globally get ignored.

I tend to agree with him. Once a share enters an index such as Tesla joining the S&P 500 Index recently, passive funds automatically buy the company’s shares despite the price being wildly over-valued already. The other thing to bear in mind is that no matter how low the charges, a passive fund will always underperform the index which of course suffers zero charges.

We have ourselves favoured passive funds over recent years by recommending Parmenion’s Strategic Passive funds. However, we have recently launched our very own discretionary fund management service through our sister company Minerva Money Management. We are open-minded about both passive and active funds believing that the best active funds will outperform most passive funds. So we consider both types of funds and select the best one for each sector based on its returns net of charges. We also favour smaller and medium-sized companies globally. Makes sense? We think so.

The recent past performance of Minerva Money Management’s CCM Intelligent Wealth Fund vindicates our approach. It is one of the best performing funds in the global sector over the last 12 months with a return of 21.9% (source Trustnet).* Over the same period the FTSE All-Share Index has fallen 9.2%. So if you had invested in a FTSE All-Share Index Tracker fund over the last 12 months you would have achieved a return net of charges approximately 30% lower than our very own actively managed fund which has an annual management charge of 1.2% which is about 1% a year higher than a typical passive fund.

Fortunately, the same Minerva Money Management team that manages the CCM Intelligent Wealth Fund will be managing the Transact Discretionary Fund Management service. So if you haven’t already chosen to invest in our new DFM proposition what are you waiting for? You know it makes sense.**

* https://www.trustnet.com/factsheets/o/oxo8/ccm-intelligent-wealth-r-inc

** The value of an investment and the income from it could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested. The contents of this blog are for information purposes only and do not constitute individual advice. You are recommended to seek competent professional advice before taking any action.

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