Actively managed funds win out over the longer term

Couple looking to future

Investors are often encouraged to "follow the institutions" and entrust most of their equity exposure to indexed trusts or exchange traded funds (ETFs) that track an index.

The argument is that these are lower cost than managed funds, and as very few active managers can justify their higher costs by consistent outperformance, you should commit your core funds to index trackers and only commit smaller chunks to actively managed funds to boost performance.

This may make sense if you are very risk-averse. However, indexed funds and ETFs will never beat their index; any costs and charges – no matter how small – will ensure they increasingly underperform over time.

Fidelity MoneyBuilder UK Index fund and Legal & General UK Index Trust are good examples. The former is the lowest-cost UK All-Share Index fund, while the latter is the largest All-Share Index tracker in the sector.

Both have lagged the All-Share every year, and are consistently in the second quartile of the UK All Companies sector in terms of performance.

It is true a lot of managed funds have done worse than the trackers, but some of the largest and oldest funds in the sector have done far better over the longer term – as have some smaller, newer ones.

In fact, the only UK mainstream funds with worthwhile returns over the last 10 years have been those where their managers have backed their own judgment. 

Actively managed funds tend to be more volatile than the index, but their long-term performance can more than compensate for any anxiety this may provoke.

Unlike an index fund, they do not need to pour more and more money into increasingly overvalued large companies, and they can invest significant parts of their portfolios in smaller to medium companies when appropriate.

Over the years, these have pulled ahead of larger rivals. But, as there are times when they look particularly attractive and times when they don't, it can be more reassuring to gain exposure through a UK All Companies fund rather than a dedicated specialist.

M&G Recovery fund is one of the oldest actively managed funds in the industry. Its policy of investing in companies when they are in difficulties and holding them until they have recuperated continues to work well.

The fund has had only three managers since its launch in 1969. Tob Dobell, who took over in 2000, has outperformed the average for the sector by nearly 50%.

Dobell explains: "We find cheap shares and good people (often when the companies have been written off), stay with them through thick and thin, and only sell when they return to favour."

He thinks the current environment is ideal for recovery-investing as so many companies have been forced to rethink their business models in order to survive. 

M&G Recovery invests in UK quoted companies of all sizes, as does Fidelity Special Situations, which has turned every £1 invested at its 1979 launch into £147. It also invests in unloved UK companies, but includes some overseas investments and is more actively managed.

Anthony Bolton managed the fund to the end of 2007, and has great confidence in his successor, Sanjeev Shah. Shah himself is very positive about the outlook for the market and his fund.

Schroder UK Alpha Plus is similarly active but has a more concentrated portfolio, which raises its risk/reward profile. It was launched in 2002 as a vehicle for Richard Buxton, the experienced head of Schroder's UK Equity team.

Those who were scared off by its 2008 setback have missed out on a stunning recovery. 

Buxton is wary about the UK economy and expects the stockmarket to be very nervous over the next six months. But he's positive about the fund's outlook: "There are a lot of good companies in the portfolio, and a lot of interesting opportunities."