Andrzej Pioch, multi-asset investor at Legal and General Investment Managers says one of the issues he has with passive investing is that it tends to leave clients exposed to a relatively small number of large stocks.
He says 60 per cent of the returns achieved by the US market over the past decade came from just six large technology stocks. As passive funds allocate based on the size of a company in an index, as each of those tech stocks rose in value, so the passive funds bought more.
This means the more those stocks rise, the more of them the passive investor owns, creating a scenario where passive investors' portfolios come to be dominated by a small number of holdings, creating concentration risk.
Small holdings
Andrew Hardy, director of investment management at Momentum says the farther down the market cap scale an investor goes, the more likely it is that active investors will win.
Iain Barnes, head of portfolio management at Netwealth, a discretionary fund house says: “We are whole-hearted supporters of the growth of passive strategies, as historic evidence shows how hard it is to pick out the managers who will become the minority of sustained outperformers in forever changing market conditions.
"Our primary aim as an investment team is always to align our portfolio construction with the firm’s overall ethos: delivering quality performance in an efficient way.
"That means usually using passive funds with active asset allocation, but you still have to choose the right funds, and that means selecting the most appropriate indices to track as well.
"An increase in stock performance dispersion should help stock-pickers as a group to showcase their skills, and if we can see a manager who is best-placed to mitigate some of the risks embedded in different market exposures – at the right price - then we don’t rule that out.”
Paul Niven, head of multi-asset at BMO GAM and manager of the firm's MAP fund range, says: “With cost-considerations to the fore the push to passive has been significant.
"Passive strategies have also enjoyed the tailwinds of favourable market conditions – an environment that has led to many questioning whether the additional cost of active management is worth paying.
"We think – at the right price point - it is, for three reasons. First is the scope to outperform – something a passive strategy inherently can’t do. Second, is the ability to protect capital in more challenging markets.
"Passive strategies enjoy the benefits of rising markets but suffer when markets do. An active strategy, however, obviously faces challenges when markets trend downwards but the impact can be limited by active decisions such as reducing market exposures, adjusting asset class and geographic weightings or emphasising more resilient companies.
