He says: “Often we will have a style in mind and usually a shortlist to start from but we’d look at all the possible options fitting the criteria and delve deeper into those that could be selected.
"It is almost always the case that we hold a mixture of passive and active exposure in our fixed income holdings as diversifying in this space is very valuable and often an active approach to an asset such as sovereign bonds is not necessary.”
Ben Yearsley, investment director at Fairview, a consultancy firm, says he views some areas of the market as particularly unsuited to the passive investment style, and so focuses on other areas.
He cites bonds as an area where this unsuitability is particularly true.
Information Ratio
Charlie Parker, managing director at Abermarle Street Partners, says it is mathematically possible to calculate the asset classes where it is better to use active than passive, using a formula he calls the “information ratio.”
He says: “If you go back ten or fifteen years, and look at the top quartile of the best performing funds in an asset class, you can see that in many areas, even if you got it right, and actually managed to pick a fund that is in that top quartile, it wasn’t actually paying you enough extra return to justify taking the extra risk that comes with active management.
"What we found was that, if you picked the right UK small cap, or indeed all cap, UK equity fund, then the rewards compared with picking a tracker that invests in those asset classes are very high indeed.
"In contrast, we found that even if you pick the right US large cap equity fund, or gilt fund, then you weren’t really better off compared to the extra risk you are taking."
Mr McDermott agrees that it is tough to find actively managed US large cap equity funds that justify the extra risk, and he citeds this as one of the few asset classes where he generally uses passive, as his default position is to use active funds.
US large caps are more difficult than many other asset classes for an active fund manager to perform well due to the sheer number of investors who buy US equities.
The market is over 50 per cent of the total global listed equity market, so in addition to all passive global equity funds having very large allocations to the US market, there are very few actively managed global equity funds in the world that would have zero in the US, and then there are dedicated US equity funds.
