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Should you dump actively-managed funds like Fundsmith after the Woodford debacle?

The Neil Woodford situation is, without doubt, an absolute debacle. Not only have investors been unable to access their money for over four months now, but the fund is now about to be wound up which means that many investors are likely to get back less than they invested. A real own-goal for the investment management industry, it begs the question: is now the time to dump actively-managed funds and invest in passive tracker funds instead?

Active funds can beat the market 

Personally, I still believe that actively-managed funds are one of the best ways to generate wealth over the long run. With this type of fund, you benefit from the experience of a portfolio manager, who will aim to outperform the market by picking out the most attractive stock opportunities.

Of course, it is difficult to beat the market consistently, particularly in the short term. Yet some portfolio managers do have excellent long-term track records when it comes to beating the market. For example, in the case of the Fundsmith Equity fund, which is run by Terry Smith, this fund delivered a return of 365% between 1 November 2010 (its inception) and 30 September 2019, versus 178% for the MSCI World Index, meaning it outperformed the market by a wide margin. Similarly, the Lindsell Train UK Equity fund, which is run by Nick Train, delivered a return of 389% between 10 July 2006 (inception) and 30 September 2019, versus 119% for the FTSE All-Share index. That’s more than three times the market return.

With a tracker fund, you’re never going to beat the market. However, with an actively-managed fund, it’s certainly possible. And bear in mind that tracker funds are relatively unproven in a major market downturn as they have only been around on a mainstream basis for a decade or so. That’s why I continue to favour actively-managed funds over passive ones, despite the fact that their fees are higher.

Understand the risks

That said, when investing in actively-managed funds, it’s crucial to be fully aware of the risks and understand exactly what you’re investing in. So, for example, with Fundsmith, be aware that it’s a concentrated fund that holds less than 30 stocks. This introduces stock-specific risk. Additionally, it has a heavy bias to the US. That’s another major risk. It’s also highly concentrated in three sectors – consumer staples, technology, and healthcare. So, there’s sector risk too. It’s essential to understand the risks before you invest. 

Risk management

Because each actively-managed fund has its own risks, it’s sensible to diversify your portfolio over a number of funds. In the same way that you wouldn’t just buy one stock for your portfolio, it’s not sensible to just buy one fund – it’s too risky. So, for example, if you’re looking to invest £10,000 in actively-managed funds, I’d split it over four or five funds with different portfolio managers and different strategies. That way, if one underperforms, your overall portfolio won’t be impacted too badly.

Overall, I still think actively-managed funds have a place in the modern-day portfolio. The key is to be aware of the risks.

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Edward Sheldon has positions in the Fundsmith Equity fund and the Lindsell Train UK Equity fund. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.