One of the key areas that seemed to ring alarm bells for shareholders was that the company suffered a £1.3bn in net outflows, which is partially blamed on the popularity of ‘passive’ funds among retail investors.
However, the company said it was “rising to this challenge” by reducing costs through restructuring and by concentrating resources on areas that it said had rising client demand and “resilient” profit margins.
What is a passive fund?
Passive funds are investment vehicles that track a market index such as the FTSE 100 or a specific market segment when deciding what to invest in.
This contrasts with active funds, where a fund manager decides what investment will make it into the portfolio.
This difference usually means passive funds are cheaper to invest in than their active counterparts, and also hold popularity with investors who may not have the time to consider individual investments or the money to pay hefty fees that often accompany active fund management.
Passives include exchange-traded funds (ETFs), which offer shares that investors can buy on the open market for the fund’s net asset value (NAV) and often track a specific index related to equities, bonds, commodities or currencies.
Advantages of passive funds
One of the key draws of passive funds is their lower cost, as their lack of active management usually entails lower marketing, distribution and brokerage expenses than active funds.
For example, according to Barclays investors in actively managed funds often pay charges of around 0.75% per year compared to some passive funds which charge less than 0.1%.
For ETFs specifically, investing in them also carries tax advantages as investors only pay capital gains tax when selling their shares in the fund and can also invest in ETFs through individual savings accounts (ISAs) and self-invested pension plans (SIPPs), which can offer additional relief from capital gains tax.
However, in some cases, the advantage of passive funds, the lack of a fund manager, can become its greatest weakness in times of market volatility, as the value of the fund will fall in line with whatever it is tracking, whereas a fund manager would be able to reorient the portfolio to avoid heavier losses.
However, Barclays highlighted that passive fund backers believe that the risk is worth it as it is “extremely difficult” to choose which fund managers will beat the performance of the market over the long term, as a manager’s “past performance should never be viewed as [an] indication of their future returns”.
Bridging the gap
While the argument continues to rage over the benefits of passive versus active funds, some funds are trying to combine the two through so-called smart beta ETFs.
A smart beta is a type of ETF that uses a rules-based system to decide what investments to include in its portfolio from a particular index, rather than simply tracking the index as a whole.
For example, a smart beta ETF may only select FTSE 100 companies that exhibit certain behaviours or financial metrics, such as low share price volatility, making it a blend of both active and passive investment strategies.