Nick Bruining: Forget the passive and the duds, now the good active managers should rise in the upheaval

It might sound a little kinky. But in the world of funds management, there are two main types of fund managers: the passive and the active.

In volatile times like we live in now, the performance difference between the two can sometimes be significant.

The passive manager is typically looking to replicate some form of index which measures the sector as a whole.

It could be a more common index such as those used in the share market including the S&P-ASX 200 Index or a more specialised index such as the S&P-ASX 200 Industrial Index.

The passive manager will weight the portfolio of the fund to perfectly replicate the components of the index. And on that basis, returns closely reflect that index — minus administration fees.

For that reason and given there’s nothing really to think about, most index funds are cheap to run and indeed the passive index model, is often at the heart of many exchange traded funds (EFTs).

The problem with an index fund is that when one or two obvious issues with particular companies or sectors arise, you’re stuck with them.

For example, when COVID-19 hit, the index fund returns were dragged down as shares in travel related companies such as Webjet and Qantas were whacked.

This might be a classic example where cheap is not always best.

Active fund managers are those who select the assets which make up the fund, based on the expertise and analysis of individual analysts.

These are the Warren Buffets (of Berkshire Hathaway fame) this world. Sometimes, they are individual personalities who are the actual portfolio managers and supposedly add value.

It doesn’t always pay off. There are a number of recent examples where high profile “show-pony” experts have made poor decisions and dragged the returns down.

It is also a brutal game. Given that an active manager will charge more for their expertise than a passive manager, they need to perform.

Sadly, most don’t with many failing to even generate returns close to those of their passive cousins.

Ideally, your quality active manager will have all the attributes of a quality business.

A stable, professional team with back-up and redundancy plans in case of illness, death or other catastrophe that might affect the business charged with managing your money.

They’ll be able to demonstrate a return better than the market over an extended period of time. Ideally in the case of shares, at least three years.

Let’s not forget that anyone can be lucky or unlucky over 12 months.

Those superior, market beating returns will be net of their expenses. Lastly, they will be absolutely transparent about what they do.

Don’t expect active managers to tell us where they are investing and what they expect in the future.

That’s their “11 different herbs and spices” stuff.

But after the event, they shouldn’t have any problem showing us where they’ve been.

After all, the proof’s in the pudding.