When it comes to investing, one of the biggest debates continues to be the choice between active and passive funds. ‘Grad Rags To Riches’ advocates for low cost global index funds (passive investing) as a straightforward and effective strategy for long-term wealth accumulation.
The latest "Manager versus Machine" report from AJ Bell provides some eye-opening insights into how active funds are faring against their passive counterparts in 2024. Spoiler alert: it's not looking great for active managers.
An investment fund is a collective purchase of assets allowing investors like you to buy into a basket of assets more easily than you could purchase them individually.
A managed investment fund or mutual fund is where assets are chosen by a fund manager using their ‘skills and knowledge’ to outperform the market, usually with a higher investment fee to you.
An Index investment fund is passive, it does not have a manager choosing assets. It simply invests in every equity or bond in an index, providing diversification at a lower cost than managed funds. An index example is the FTSE 100 which is the 100 biggest companies in the UK stock market, or The S&P 500 which is the 500 biggest companies in the US stock market. A global index can contain Equities or Bonds from markets all over the world.
Investment Fees: When you invest in a fund the provider makes a charge which could be anywhere up to 2% for a managed fund; index funds tend to charge less than 0.5%. Imagine if your fund is returning 5% and then you lose 2% of this in fees!
Rather than relying on a fund manager to pick shares they think are going to do well, index funds ‘track’ the overall performance of an entire market index and because they typically have lower fees, you keep more of your returns - which can really add up in the long run.
Active vs. Passive: The Numbers Don't Lie
According to the "Manager versus Machine" report, only 35% of active equity funds outperformed the average passive fund in 2024. If you think this is just a short-term blip, think again - over the last 10 years, the figure is exactly the same. The number of Global active funds is even worse at just 19% over the last 10 years.
The reason? The stock market has been dominated by a handful of tech giants like Amazon, Apple, and Nvidia. If active fund managers did not invest heavily in these, they were left behind. But if they do, they are basically just expensive passive funds. So, why pay more?
If you remove Global and US funds from the equation, the outlook for active management improves slightly. In that case, 46% of active funds outperformed passive funds over 10 years. While still not a majority, it suggests that in certain regions - such as Asia-Pacific (ex-Japan) and emerging markets - active managers have more opportunities to add value.
Are There Any Bright Spots for Active Funds?
No, not really. Over 10 years, the average active fund was beaten by the average index fund in all sectors except ‘Asia Pacific ex Japan’ and ‘Global Emerging Markets’. Even the top performing active fund managers did not do much better when higher fees were taken into account.
In the case of the top performing Global managed funds, they were beaten by the average Global Index fund.
Pension Funds: An Even Bigger Disaster for Active Managers
If you think active investment in standard funds is bad, wait until you see what’s happening with pension funds. The numbers here are even worse - just 24% of active pension funds have beaten a passive equivalent over 10 years.
Some sectors have done particularly badly: Just Nine Percent of Managed Global Pension Funds Have Beaten Global Index Funds over 10 years, and with high fees eating into returns, it’s no wonder many pension savers are stuck with underwhelming results.
Where is the Smart Money Going?
Investors have been voting with their wallets, and the trend is clear: they are ditching active funds. Since 2022, £89 billion has been pulled from active funds, while £37 billion has flooded into passive funds. It is clear that more and more people are realising they can get similar, or better returns for a fraction of the cost via index funds.
Global Index Fund or USA Index Fund?
The stock market’s growth often comes from just a handful of companies. In recent years, “The Magnificent Seven” a group of dominant U.S. tech giants has driven most of the market’s gains.
This raises a big question: should I just invest in the U.S. via the S&P 500?
A study of nearly 29,000 stocks from 1926 to 2023 found that just 86 companies accounted for half of all market returns. The truth is that today’s top companies won’t always stay on top. If you only invest in the biggest names now, you risk missing the next wave of market leaders. The same could be true if you only invest in one Stock Market – It’s not that long ago that the UK was the biggest and best!
The U.S. stock market is around 60% of a global index fund. Within this, Microsoft is such a big company that 5p in every £1 is invested just in them. But if Microsoft started to shrink in size and fade away, that allocation would shrink with it. It is really as simple as that. As companies’ values change or as companies enter or leave the index, these weightings adjust over time.
Instead of trying to find that needle in the haystack, legendary investor Jack Bogle suggested, “Buy the whole haystack.” That is where diversification comes in. Investing in index funds, which hold hundreds or thousands of stocks, spreads risk and ensures exposure to future winners without the stress of stock picking.
Diversification across industries, asset classes, and global markets helps investors navigate economic downturns while benefiting from market upswings. The smart strategy is to focus on long-term growth, aiming for steady returns rather than overnight riches.
What Does This Mean for You?
If you're investing for the long term, this data reinforces the argument for passive investing. While active managers may add value in niche areas like small-cap stocks or emerging markets, the odds of consistently beating passive funds, especially in major markets like the US are low.
That said, not all passive funds are equal. The report highlights a huge difference in performance between similar index funds. For example, one FTSE 100 tracker turned £10,000 into £17,940, while another managed just £16,400—simply because of higher fees.
The moral of this story – always check what fees you are paying even for global index funds – make sure they are low cost, especially in your pension scheme.
The Bottom Line
You might be paying 0.2% of your investment per year in fees in an index fund, but in an actively managed fund it will be closer to 1%, maybe even higher. So considering the fact that these actively managed funds have struggled to beat passive investing in the past and that the fees are higher, this can have a massive impact on how much money you end up with.
The "Manager versus Machine" report makes it clear: passive investing is winning, and active fund managers are struggling to justify their higher fees. If you're looking to maximize your investment returns, focusing on Low Cost Global Equity funds may be the smartest move.
Buy and Hold Low Cost Global Index funds in Pensions and ISA’s for the long term regardless of fluctuations in the market.
“Time in the market, not timing the market”.
This is the way to grow your wealth!
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