Specialist Outlook

Active or passive? Not an easy decision

18 August 2015

The majority of charity portfolios are actively managed. Why is this, and should more trustees adopt a passive approach? The ‘active versus passive’ debate has re-surfaced after a period of under-performance from many active equity managers…

The decision is not as simple as it first appears. We have broken down the investment services required by a charity into three parts: strategy, implementation and administration. We consider each from both an ‘active’ and ‘passive’ point of view, explaining why the theoretical appeal of index-tracking has not proved as attractive in practice for charities.


This is probably the most important arrow in an active manager’s quiver, as most active ‘full service’ managers will help trustees turn a charity’s objectives into a plausible investment policy and strategic asset allocation. All investors have risks to mitigate. Are they trying to preserve capital in absolute or ‘real’ terms? Do they need to produce a specified level of income or invest in an ethically sensitive way? Perhaps capital disbursements need to be planned over multiple years.

The strategic skills that an experienced charity investment manager brings to a trustee board are extremely valuable: weighing up assets and liabilities; considering a wide range of individual asset classes; assessing plausible risk and return expectations based on historic return trends and current markets. The aim is to design a robust investment policy that matches the charity’s particular requirements, is robust under a wide range of scenarios and finds the most appropriate combination of asset classes to maximise the risk-adjusted return.

Strategy is not to be looked at every 5-7 years when a manager is reviewed. A good manager will be proactive, regularly monitoring a charity’s strategic asset allocation and whether this needs to change. One only has to look at the WM Charity Survey to see how asset allocation has evolved over time. New asset classes have been introduced and the balance between some of the core asset classes has altered appreciably. A passive approach to asset allocation can mean long-term strategy is ‘cast in stone’, which does not easily accommodate the evolution required.

Conclusions: There are few (if any) passive investment managers who offer a comprehensive strategic service for charities. On that basis, trustees who choose the passive route will probably employ an independent investment consultant. From a strategic perspective, the benefits of appointing an active charity specialist can hold significant value. The costs one pays are typically not just covering the costs of active day-to-day investment management.


Active investment managers try to add value in a multitude of ways, which can broadly be split between tactical asset allocation decisions and active stock selection. In this article, we will primarily focus on stock selection.

Although the results of active investment can be quite significant in individual years (over or under performance of an index or benchmark by perhaps 3-5%), over periods of five years or longer, it would be typical to target outperformance of 1-2%. Sadly, the data would suggest this is an aspiration! The majority of fund managers do not outperform after fees and certainly not by more than 1% per annum, a level of skill that is perhaps possessed by less than 15% of the market.

This is why index-tracking funds appeal: achieving performance in-line with a benchmark or index is quite an achievement.

That said, there are moments when active fund managers do perform: whilst the majority of UK equity managers under-performed the FTSE All Share index over the last 12 months, the majority out-performed over the last three years.* Moreover, charities generally pay lower fees than retail investors, so charities adopting an active approach to stock selection have a better chance of achieving the premium returns they seek.

At this point, the case for passive management is powerful. However, there are four further problems that those seeking passive investment need to consider.

1. Some asset classes and sub-sectors are easier to track than others: most equity and bond markets can be tracked easily and cheaply. However, achieving exposure to property and alternative assets through trackers is much harder. This can present trustees with problems given that allocations to these asset classes are often recommended to be between 10% and 25% of long-term endowment funds.
2. There are two areas specific to charities that can make a passive approach difficult to implement: income targets and ethical restrictions. Although recent legislation means that most charities can adopt a total return approach, many charities’ budgets rely on higher levels of income than naturally flows from their investments. This income tilt can, in part, be achieved through asset allocation, but often a portfolio’s equities need to be structured to produce a higher level of income than an index naturally provides.
3. For those charities whose ethical policy demands the avoidance of specific sectors or companies, index trackers will tend to fail the levels of transparency and adherence now expected of UK charities. Interestingly, whilst it is perfectly feasible to construct passive funds to incorporate ethical requirements, in reality, the choice is limited.
4. There is the often forgotten issue of which index to track. In investment, risk is typically transferred, rather than erased. The trick is to know both the risks you are erasing and which new ones you will add. Picking indices is an ‘active’ decision. For example, the difference in performance between two global equity indices, the MSCI World Index and the FTSE All World Index was 16.7% over the ten years to 30th June 2015. Which will perform in the future?
Conclusion: At first glance, the performance after costs of many active fund managers makes index-tracking appealing. In practice, the decision is less simple. If it were just about stock selection, then we would expect to see more charities investing passively, but in the real world, the decision is not so clear-cut.


While reasonably straightforward, reporting and administration is critical and, in our experience, many charity executives and trustees come to rely heavily on the supporting services provided by their investment manager. Active management normally includes the safe custody of the charity’s assets together with the preparation of regular reports to monitor progress as well as a number of meetings throughout the year.

The costs of passive management are very appealing. They are lower than active management because of the simplicity. However, by taking a passive route, much of the onus switches to the trustees and executive, which can be burdensome. For smaller charities, where there are multiple trustees and signatories for example, signing up to a trading platform can be as challenging as opening a bank account.

Moreover, the low revenues earned by passive managers mean that they are typically unable to provide other services such as trustee training, investment seminars, market commentary, income modelling and return projections. Perhaps most importantly, with active managers, trustees have a human contact with whom they can discuss the charity’s investments and wider issues within the charity sector. First class administration and service is a must and without it, the burden placed on trustees increases considerably.

Conclusions: Low costs typically come with low levels of client service.

Has active management worked for charities?

Using the WM Charity Survey as a proxy, it is clear that the average actively managed charity has achieved excellent absolute returns over the last 30 years or so. The annualised weighted average return is 6.5% per annum above inflation.** The return is before most costs but, even adjusting for these, the return is likely to have met most trustees’ aspirations.

Interestingly, the 75th percentile charity achieved a real return of 4.3% per annum: even those with sub-par returns have achieved very reasonable results. For those lucky enough to have achieved a better than average result, the 25th percentile fund in the survey achieved 8.4% after inflation per annum – so the value added by the better active managers has been considerable and the aspiration that one’s own charity can achieve results like this are clearly why so many investors try to find the best active managers.

The conundrum for those considering the passive approach is working out how much of these good and bad returns was the result of the different strategic asset allocations of the portfolios, as opposed to the tactical asset allocation and active stock selection decisions? Where would a passive approach have appeared? One cannot assume it would have produced the average return. A fund manager who adopted a good strategy could still have produced top quartile results even if their active stock selection was weak. Alternatively, a charity with passive stock selection could perform poorly if the asset classes were inadequately mixed together. On balance (and we probably would say this as we are unashamedly active managers with strong strategic underpinnings!) we think the overall and comprehensive package that can be provided by a ‘full service’ active manager remains the best option for most charities.

However, it would be wrong to dismiss the passive approach. What’s more, active managers who consistently deliver poor returns and fail to deliver any strategic or administrative value will find it hard to compete with cheap, passive alternatives.

One final thought: active doesn’t have to be wildly active. Whether it be at the stock selection or asset allocation level, trustees can dictate the level of active risk assumed within the portfolio by applying operational risk controls such as asset allocation operating ranges or restrictions on the ‘active money’ both of which control the potential deviation from the index. Maybe that is the best of both worlds…


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Robert Boddington

Robert Boddington is a partner and Chief Client Officer at Sarasin and Partners.

Robert specialises in investment management for charities. He joined the firm in 1988 and has over 25 years of investment experience. He is an Associate of the Chartered Institute of Secretaries and a Fellow of the Chartered Institute for Securities & Investment.

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Richard Maitland

Richard Maitland is a partner and Head of Charities at Sarasin and Partners.

Richard has more than 22 years of investment experience and joined Sarasin & Partners in 1992. In addition to UK equity research, Richard has led the firm’s third party funds research team, analysing specialist equity funds and alternative assets while managing portfolios for a range of charities, pension funds and unit trusts. He now focuses on managing diversified multi-asset portfolios for charities and assists in setting the firm's long-term strategic asset allocation. He is author of the Sarasin & Partners Compendium of Investment. Richard has a degree from Newcastle University and is a member of the St Paul’s Cathedral Investments Committee.  He has been a visiting lecturer on investment and endowment management at the Judge Business School and the Universities of Stellenbosch and Vienna.

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