Chris Daems, director of London and Essex-based Cervello Financial Planning, uses passives because of the uncertainty of predicting which active funds will outperform the index.
‘We believe only about a third of active fund managers outperform their index,’ he said. ‘If you have two-thirds who underperform but you do not know which ones they are going to be over the next five years, you could take a passive portfolio at lower cost that allows the adviser to add more value to the client.’
Client demand for passives
Cervello was previously more actively focused but has moved toward passives following growing client demand.
Most of the firm’s clients are between 55 and 70 years old, approaching retirement and generally want to reduce the unknowns in their lives. Daems said their liking for passives was driven by an increasing focus on the transparency of fund charges and a body of evidence that questioned the value of active fund management in generating long-term outperformance of the index.
Clients can choose between active and passive across the firm’s portfolios from risk profiles two to eight.
Long-term buy and hold
Cervello has an asset allocation-driven, long-term buy-and-hold approach. Daems keeps abreast of short-term market movements across asset classes but does not allow that to over-influence his longer term view.
‘What I’m not keen on doing is making changes for change’s sake,’ he said. ‘Funds might be removed if there is a better alternative available, but cost is a key issue when considering portfolio changes. Every change has a time cost for the business and a cost to the client.’
He said passive management could work well with UK equities, and believes there is a high degree of correlation between active funds, which he complained broadly invested in the ‘same companies often with relatively similar proportions’.
Cervello tries to keep personal bias out of the selection process. The firm’s research for all passive funds is conducted on a biannual basis. It starts by identifying client portfolio requirements, then filters down the universe of passives using objective criteria, such as cost, asset class indices required and the financial strength of the fund house.
The firm reviews funds annually. Potential trigger points are created when funds change their cost or there is a broad change in the market pricing of other fund alternatives making them relatively cheaper.
‘We don’t review funds every time costs change,’ said Daems.
Legal and General UK Index Trust
Legal & General UK Index Trust is a fully replicated fund, which tends to be more expensive but has a more precise approach. It closely replicates the FTSE All Share index and has 659 holdings.
‘We decided on this particular fund, which tracks the FTSE All Share, as opposed to a more restrictive choice, like the FTSE 100, to provide greater diversification but potentially more volatility,’ said Daems.
The fund is £4.5 billion in size.
- Total cost: 4/5
- Tracking error: 4/5
- Overall usefulness: 4/5
- Firm’s allocation: 11%
Vanguard FTSE UK All Share Index Unit Trust
The Vanguard FTSE UK All Share Index unit trust has 556 stocks as of 30 September 2015, slightly less than the whole FTSE All Share index. The fund nevertheless manages to track the index closely by selecting the most representative stocks.
Daems said the fund differed from the Legal & General fund above due to its lower costs and reduced tracking error.
The fund is £3.9 billion in size.
- Total cost: 5/5
- Tracking error: 5/5
- Overall usefulness: 5/5
- Firm’s allocation: 14%