All this week we are running a Guide to Active and Passive Investing to help you, the investor, make smart choices for your portfolio.
Emma Wall: Hello and welcome to Morningstar series, "Ask The Expert." I'm Emma Wall and I'm joined by Morningstar Passive Fund Analyst, Kenneth Lamont.
Hello Kenneth.
Kenneth Lamont: Hello, Emma.
Wall: So, we're focusing on passive investing today as a part of our wider active and passive week. I thought we'd start by asking which are the cheapest passives?
Lamont: Well, the core exposures are generally the cheapest. So, perhaps an index fund or an ETF tracking, the FTSE 100 or the S&P 500 equity indices would be very cheap, perhaps as low as 5 or 7 basis points.
Wall: That's unbelievably low because that's sort of £5 for a £1,000 investment a year.
Lamont: It's incredibly low. The margins that these funds operate on are razor thin.
Wall: It means that the market doesn't actually have to go up that much in order for you to make a profit?
Lamont: Absolutely. You are tracking the fund and often in some cases you might get a little bit more than the market too depending on the fund.
Wall: You've mentioned the equity funds are cheap there. Equity funds on the whole then are cheaper to run than fixed income funds, is that fair?
Lamont: No, no. There are some very cheap fixed income funds as well. It just depends really on the underlying exposure you're looking for, perhaps a more niche exposure, more and more complex equity exposure would also be more expensive.
Wall: Then why we are talking about price because it is the main driver for a lot of people to make the decision to go passive, although it's only one of the considerations that you take into consideration when rating a fund because we have these 5 P process for active management, Price, Performance, People, Parent and Process. But we apply them to passive funds as well, don't we? So, Price is only one of those. Perhaps you can explain how that works.
Lamont: Yes, certainly. I mean, as you mentioned, Price is one of the big attractions. But Price and Performance are interlinked and also the Parent is also extremely important, your trust in the company behind the fund's ability to support the fund management team.
Wall: But of course, certain things are more important – certain Ps are important with passive funds than they might be with active funds because with active funds you really might want to pay quite a lot of importance on People, the person who is making those very active decisions, which are going to determine whether or not you have positive returns, but with passives it's Price that can really eat into returns.
Lamont: Well, it's with active that price can really eat into your returns. With passive, the price will eat less into your returns, generally speaking. But yes, of course, there are people behind the product, but the scope and the amount that they can do to bring you excess returns is minimal. Their task is to track an index rather than to beat one.
Wall: You did mention their Parent and you said that was important with passives. Are there any particular houses that produce passive funds that are renowned for being incredibly low cost?
Lamont: Well, as sort of the major players in both index funds and ETFs perhaps would be BlackRock, I mean, under iShares for ETFs or Vanguard, although there are many different players within these and many very good different players within these markets.
Wall: Kenneth, thank you very much.
Lamont: Thank you, Emma.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
