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Why active management has a place in 2025 and beyond

The rise of passive investment is storing up risks that many investors may not realise they are taking. James Crossley, our head of Rathbones Asset Management distribution, makes the case for active managers.

By James Crossley 4 December 2024

It’s been yet another volatile – but profitable – year for markets, reinforcing the old adage that it’s time in the market that counts, rather than trying to time markets. I don’t have to tell you that staying invested and focusing on the long term tends to be the best advice for the bulk of clients. 

Yet this advice can be so hard to give, especially with today’s 24/7 news cycle, daily portfolio prices accessible on everyone’s phone, and political upheavals creating uncertainty with disquieting regularity. But in reality, it’s always been like this. Except the phones. They’re new. But they just make the old cycles seem louder, more insistent and more unique: the future has always been uncertain. Governments have changed. Wars have started and ended. Energy prices have varied. People have argued. Fashions have come and gone. And through it all, stock markets have risen. Those who have invested have been rewarded well above those who have saved in cash or spent all their money. We think this is such an important message for underlying clients, and one that we work hard to help our IFA partners convey.

These figures refer to simulated past performance, which isn’t a reliable indicator of future performance

Speaking of changing fashions, the prevalence of passive investments is having a noticeable impact on investing. The rise of passive, allied with technological improvements, has reduced the cost of investment and made it easier for more people to invest. This is undeniably a good thing. But just as we think passives have a place and a role to play in portfolios, we believe active management does too. Both have pros, both have cons. It’s critical that we are aware of them.

Active management costs more. But it can also deliver more. It’s well known that the average active fund manager doesn’t beat the benchmark, but most managers are just expensive trackers. They aren’t making truly active decisions that allow them to deviate from those indices. It is possible for quality managers to deliver market-beating returns over 10, 20, 30 years. An active approach can be used to control volatility, offering smoother returns that help clients plan their lives better. 

Of course, by definition, active management introduces deviation from a benchmark. That makes it important to understand exactly what you’re investing in. It’s the Ronseal test: will it do what it says on the tin? We think that risk is mitigated by looking for teams with long track records, who have a clear process and a strong culture. Often, this combination can be found in smaller, boutique fund houses which can focus on what they do well, rather than trying to be all things to all people. 

Seven ride into town, three ride out

As for the cons of passive investing, the main one is what you don’t get. You don’t get the companies of tomorrow, you get those at the top today. You miss the discovery of great businesses before they join the ranks of the large and established. Meanwhile, greater passive investment can reduce the funding received by these worthy up-and-coming companies, to the benefit of incumbents.

Another con is today staring us all in the face: concentration risk. Passive strategies overwhelmingly use market-cap-weighted indices. This means new flows mostly go straight into the largest, most expensive companies, making them yet larger and more expensive. The Magnificent Seven tech companies astride the S&P 500 make up almost 35% of the entire index. Now, they are there for a reason: these are great companies, many of which we own. But putting more than a third of a stock portfolio into fewer names than you have fingers is blatantly a risk. Remember, in the film, only three come out alive.

Passives have done very well in the bull market of the last decade as stocks have forged ahead, led by fewer and fewer companies at the very top. By their nature, passive investment flows exaggerate those moves and give them momentum. That could very well work the same way on the way down. 

 

 

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