USS weighs in on active v passive debate

Earlier this year the government suggested that local government schemes should pool all listed assets into a passive collective investment vehicle, saying £420m could be saved a year. However, critics have said that active managers play a role in ensuring shares are valued correctly and company management is held to account. 

We had an ability to sell the shares in those companies, had we been passive we wouldn’t have been able to do that

Elizabeth Fernando, USS

Speaking at the Financial Times's European Investment Management Summit this week, Elizabeth Fernando, head of equities at the Universities Superannuation Scheme, said many active managers do not consistently add value over time.

“The vast majority of managers are more interested in asset gathering than they are in asset management, and that sets up a conflict of interest with the asset owners who they are managing on behalf of,” she said. This has resulted in a short-term approach to these funds, Fernando added.

Michael Johnson, research fellow at Centre for Policy Studies, said: “Part of my dislike of the active world is just immense complexity and excess of choice, that makes the decision-making for the man on the street completely impossible.”

The majority of the £41.6bn USS’s equity portfolio is actively managed by an internal team. Fernando said: “There is evidence that internally managed funds generally do better than externally managed funds and we work very hard on ensuring that our internal teams take a longer-term perspective on their investment decision-making.”

Fernando said USS has an advantage of having a large pool of assets which means it can internally run active management at a low fixed cost.

“So internally we can manage our equities portfolio, for example, for not far off the cost of externally managed passive mandates,” she said. “We view our internal team as being pretty much a free option for outperformance.”

Laith Khalaf, senior analyst at Hargreaves Lansdown, said passive funds are gaining ground within the pensions arena.

“Just over 40 per cent of pension funds are now invested passively and we’ve now had the UK government saying there is going to be a charge cap on default funds of 0.75 per cent – that is only going to drive assets one way.”

But he said active managers play a role in allocating capital to markets and keeping corporate managers honest in their dealings with shareholders. “And if we lost all of that, then you would reduce gross market returns to all participants,” he said.

Fernando said the stock markets exist to allocate capital to the most deserving, highest-return corporations. “It is the active managers… that set the cost at which that capital is provided,” she said.

“The passive managers, if they are following a market-cap weighted benchmark, are implicitly stating they are accepting the relative value the market has placed on the relative value of shares, and that may or may not be a sensible thing to do.”

Fernando said that during the financial crisis, USS’s internal team was very underweight banks because the price of these stocks had hit a point where the return could no longer be justified.

“We had an ability to sell the shares in those companies; had we been passive we wouldn’t have been able to do that,” she said. “So we created a lot of value for our pensioners during that period.”