Sunday 27 May 2018

Should I follow passive investment trend?

Your questions answered by David Quinn, Managing director at Investwise

Email your questions to or write to ‘Your Questions, Sunday Independent Business, 27-32 Talbot Street, Dublin 1’.
Email your questions to or write to ‘Your Questions, Sunday Independent Business, 27-32 Talbot Street, Dublin 1’.

Q: I've been reading a few articles internationally reporting on a huge growth in investor interest in passively managed funds like index and ETFs. Has this growing popularity spread to Ireland, and if so, what's the catch? A few commentators seem to be saying that because there's so much money pouring into these types of funds at the expense of actively managed funds, this can't be a good thing for stock market returns generally. Do you agree? Sharon, Galway city

There has been a wide ranging debate on this topic in investment circles for the past 40 years ever since Jack Bogle, founder of Vanguard, started the first indexed fund.

Passive investment funds, such as indexed funds offered by the pension and life assurance firms here or exchange traded funds (ETFs) simply track the performance of an index as closely as possible.

They tend to be very low-cost, relative to their actively managed counterparts, and investors have been flocking to the passive approach for this reason.

Passive investment funds represent just under 30pc of the overall investment market, with this percentage expected to pass 50pc in the next three to five years.

There is a concern that this level of passive investment will make markets inefficient, as there won't be enough active analysis to accurately value stock prices.

There is also a view that as markets pass all-time highs and start to appear expensive, active managers will add value in the next few years by protecting investors from the most over-valued stocks. An index tracking fund will just hold the entire index, regardless of valuation.

There is very little actual evidence that active fund managers protect investors in a downturn, though. I feel there is plenty of scope for further growth in the passive investment space without markets becoming inefficient, and I encourage clients to invest passively in many cases, particularly for European and US equity allocations.

Some active fund managers and stock brokers will 'beat the market' and outperform their passive alternatives every year (approximately 25pc of them in fact) but, in my experience, it is almost impossible to identify those lucky managers in advance.

Once we push out the time frame to five years or more, the percentage of active fund managers that beat the market falls to single digit percentages.

I think there will be a natural levelling off of the growth of passive investments as biases in investor behaviour will always lead some investors to seek out an active approach.

Is higher-risk punt worth it?

Q: I have a €40k lump sum, but given rubbish interest rates, should I use it to pay down some of my mortgage, put it into a property fund or REIT (Real Estate Investment Trust), or take a punt on the stock market? I don't have to touch it for at least five years, which is why I'm considering higher-risk investments as well as other options. Can't decide! Niall, Mullingar, Co Westmeath

This is a very common question at the moment and depends on a couple of factors. Firstly, I would like to know that you have a rainy day fund in place before investing or paying off a mortgage. If this is your only savings, I would recommend keeping a portion in an easy access deposit account which is safe and will act as your emergency fund. How much you keep safe in this account will depend on your personal circumstances and commitments. Those with a family and single income will require a larger 'rainy day' fund than a young single person.

Secondly, and assuming there are other savings already in place, the decision as to whether to pay the mortgage down is heavily dependent on the mortgage interest rate. I almost always assess the implied rate of return in paying the mortgage when assessing this decision. What return would you need in the REIT or stock market investment to beat this rate of return?

For example, an individual on a 3.5pc variable rate would need an return of 6pc (before tax) on their investment, in order for it to make sense NOT to pay down the mortgage. If the investment delivers a return below this, the interest saving achieved by paying the mortgage would be higher than the investment return. Therefore, those on a good tracker mortgage rate can probably match or beat their interest cost quite easily without taking much risk, whereas those on a high variable rate will find this much harder to do.

Paying off the mortgage is almost risk-free, whereas an investment that has the potential for a 6pc per annum return is likely to be very high risk. A good financial planner should be able to help with this decision, by modelling both scenarios into the future and then comparing the outcome.

Are broker's picks way to go?

Q: My current broker is recommending an investment platform, with a selection of funds he has chosen himself. Should I consider this service, or just use an off-the-shelf investment portfolio that the life assurance companies offer? James, Naas, Co Kildare.

We have started to see some growth in the investment platform market in Ireland in the past five years. It is a very fast growing sector in the UK, and is starting to dominate the market there. Platforms offer you an easy to use service which gives a wide range of investments across multiple investment providers. This gives investors more choice and flexibility than the traditional investment with a single life assurance company, who may offer 20 of their own funds and a very limited range of external, third party investment managers. Some brokers will research the wider market and design their own model portfolios within these platforms.

Before actually investing in one of these portfolios, I would ask the broker to explain how he selected the funds, and also how he will manage those portfolios on an ongoing basis. The main problem I see with these self-selected portfolios is ongoing management. There is significant administration requirements to make sure these portfolios are efficiently rebalanced every year and the strategic and tactical asset allocation is reviewed.

There are also some potential tax pitfalls with using a platform. Life assurance companies offer a 'wrapper' service, which allows fund switching without any tax charge. In platforms, I have seen portfolios where each individual fund within the portfolio is taxed separately and this can be very inefficient. A full service offering with a broker/platform can be expensive, and the life assurance companies provider similar portfolios, often for significantly less cost.

I like the platform services, and they can offer very cost effective and transparent access to global portfolios, there is just more scope for problems so the investor needs to spend some time understanding the proposal. If they don't have time to do this, I would recommend considering an off-the-shelf solution model portfolio service with the life assurance companies.

Sunday Indo Business

Business Newsletter

Read the leading stories from the world of Business.

Also in Business