Kyle Caldwell names the passive strategies that have caught the eye by outperforming many fund managers over the past five years.
Fund sales have been picking up lately, but it is passive strategies that many investors have been flocking to rather than active ones.
This is reflected among interactive investor customers, with index funds dominating. Since the start of this year to the end of April, just two active funds appear in our top 10 most-bought funds list, namely Fundsmith Equity and Royal London Short Term Money Market, ranked first and eighth respectively.
On the whole, passive investors are favouring ‘plain vanilla’ exposure to developed markets, which is a trend that also extends to exchange-traded funds (ETFs).
The passives that are tough to beat
Some stock market indices prove to be a tougher nut for active managers to crack.
The S&P 500 index, for example, is notoriously difficult for fund managers to consistently beat, given that it is the most widely researched and followed index.
By the same token, active fund managers who invest in small companies tend to have a greater percentage of outperformers. Smaller stocks tend to be more volatile and less well researched than large companies, which gives active managers a better chance of beating a benchmark that simply owns stocks according to their size.
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Below, we name passive strategies that have caught the eye by outperforming many fund managers over the past five years.
L&G Global 100 Index Trust
Over multiple time periods – three months, six months, one year, three years and five years – L&G Global 100 Index Trust has produced top quartile performance in the Investment Association’s (IA) global fund sector, according to FE Fundinfo. As at 23 May, the fund’s five-year returns show a gain of 85.2% versus 42.3% for the global sector average.
The key reason for the outperformance is the make-up of the S&P 100 index that the L&G Global 100 Index Trust tracks.
The index holds multinational blue-chip companies of major importance in global equity markets. Companies included in the underlying index are screened for global exposure, sector representation, liquidity and size. Stocks with relatively larger sizes and higher liquidity are preferred.
In common with most indices, the S&P 100 is market-cap weighted, ranking companies by their size and share price success.
The market cap of a company is the total number of shares in existence multiplied by the price of those shares. If a company’s share price goes up relative to other members of the index, it will represent a higher percentage of the index.
The end result for L&G Global 100 Index Trust is that this index has significant weightings in the US technology behemoths that have delivered exceptional performance for most of the past decade, with 2022 being an exception as tech share prices and valuations re-priced in response to interest rates rises. Year-to-date, however, Big Tech has staged a major recovery on the back of the artificial intelligence boom.
As at the end of March, L&G Global 100 Index Trust had more than a third of its assets in four US tech stocks: Apple (NASDAQ:AAPL), Microsoft Corp (NASDAQ:MSFT), Alphabet (NASDAQ:GOOGL) and Amazon (NASDAQ:AMZN). The respective weightings were 14.1%, 12.3%, 6.6% and 5.3%.
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Investors need to question whether the outperformance of Big Tech can continue, as well as if they are comfortable with those stock weightings, particularly in the case of Apple and Microsoft.
Other global trackers topping the charts
Over the past five years or so the performance of global and US stock markets has been heavily influenced by a small number of very large stocks – primarily the US tech giants.
This has made the period a challenging environment for active fund managers – particularly those who hold less exposure than the index in these companies, the likes of Amazon, Apple, Alphabet and Microsoft.
Global index funds and ETFs have benefited from this trend, with five-year returns of 57.2%, 57.2%, 57.8% and 57.8% for the iShares Core MSCI World ETF, Xtrackers MSCI World ETF, Fidelity Index World, and Invesco MSCI World ETF. This is comfortably ahead of the global sector average return of 42.3%.
Low-cost exposure to the US market pays off
In the US, there’s been similar levels of outperformance for passive strategies that track the ups and downs of the S&P 500 index. Over five years, the iShares Core S&P 500 ETF and Vanguard S&P 500 UCITS ETF have returned 78.6% and 77.5%. In contrast, the IA’s North America sector average return is 63.5%. Over all other time periods (three months, six months, one year and three years), the duo have outpaced the sector average. Both charge just 0.07% a year.
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As you would expect, the same stocks are held, with the biggest positions being: Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT), Amazon (NASDAQ:AMZN), NVIDIA (NASDAQ:NVDA), Alphabet (NASDAQ:GOOGL), Tesla (NASDAQ:TSLA), Berkshire Hathaway (NYSE:BRK.B), Meta Platforms (NASDAQ:META), Exxon Mobil (NYSE:XOM), and UnitedHealth Group Inc (NYSE:UNH).
Buffett ETF for US market outperforms sector average
A strong and long-lasting economic ‘moat’ was described by legendary investor Warren Buffett (pictured above) two decades ago as the “most important” factor when sizing up a potential investment.
To have a wide moat, businesses need to have some sort of edge that keeps competitors at arm's length, such as a powerful product or brand with a loyal customer base, intangible assets, a patent on proprietary technology or the ‘network’ effect, whereby goods and services become more valuable as more people use them.
A key part of having an economic moat is pricing power, which hands companies the ability to pass cost increases on to consumers, and keep margins high. This is potentially a great benefit in a world of higher inflation.
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Rather than personally trying to work out which companies have a moat, there are two ETFs that track an index of companies deemed to: the VanEck Vectors Morningstar US Sustainable Wide Moat ETF (LSE:MOAT) and VanEck Vectors Morningstar Global Wide Moat ETF (LSE:GOAT).
Over the past five years, figures from FE Fundinfo show that the VanEck Vectors Morningstar US Sustainable Wide Moat ETF has returned 76.9%, outpacing the North America sector average return of 63.2%. Over three years and one year, performance is more middling, up 33.3% and 8.6% versus 38.1% and 7.5% for the sector average.
The VanEck Vectors Morningstar Global Wide Moat ETF does not have a five-year track record. Over three years it is up 30.2%, while over one year it has gained 4.5%.
Vanguard FTSE UK Equity Income Index
Over the past three and five years Vanguard FTSE UK Equity Income Index, a member of interactive investor’s Super 60 list of investment ideas, has had the upper hand over the UK equity income sector average, up 47.3% and 13.1% against 42.2% and 11.7%.
As well as its performance beating many fund managers, it generates a higher yield than most pros, currently 5.1%. The reason is because the index it follows – the FTSE UK Equity Income index - consists of shares “that are expected to pay dividends that generally are higher than average”.
In contrast, actively managed UK equity income funds tend to yield between 3.5% and 5%. The reason is down to most funds aiming to strike an appropriate balance between risk and reward in an attempt to deliver both capital growth and income.
Therefore, its performance and income generation is heavily influenced by the biggest FTSE 100-listed dividend stocks. Its top 10 holdings account for around half the portfolio, while financials account for a quarter of assets. In total, 111 stocks are held, and the top three positions currently are National Grid (LSE:NG.), Unilever (LSE:ULVR), and GSK (LSE:GSK).
Vanguard LifeStrategy range
Last, but by no means least, the Vanguard LifeStrategy fund range has consistently outperformed most actively managed multi-asset funds since it launched over a decade ago.
Vanguard’s ready-made portfolios hold a collection of its own index funds and ETFs. Each of the five LifeStrategy funds holds a different proportion of shares, ranging from 20% to 100%, with the remainder in bonds. Three of the funds; the 20% Equity, 60% Equity and 80% Equity versions form part of interactive investor’s Quick-start Funds range that offers a simple starting point for investors.
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In 2022, the five funds in the range did not perform in line with their level of risk, as the 20% version produced the biggest losses, followed by the 40%, 60%, 80% and 100% options. This was due to sharp interest rate rises, which caused bond prices to fall, meaning the LifeStrategy funds with greater exposure to bonds saw their performances suffer more.
Over five years, all five LifeStrategy funds have outperformed their most relevant IA fund sector.
The low costs, with each fund having an ongoing charges figure (OCF) of only 0.22%, make it challenging for actively managed multi-asset funds to beat them. A typical OCF for an actively managed multi-asset fund is around 1%, while multi-manager funds, which invest in other funds, tend to be even more expensive, typically around 1.2% to 1.5%.
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.
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