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Continued passive strategy could pose risks to investors and the economy

16 September 2018

Investors require a mix of active and passive investing and the recent trend towards passive investments could pose risks to individual investors and the economy, warns a new policy paper from Royal London.

The group said trillions of dollars have flowed out of active investments and into passive funds since the financial crisis of 2008. As a result, passive investing in shares accounts for nearly half of all assets under management.

While Royal London endorses the use of passive funds, it warns that if passive investing were to be totally dominant, individuals risk being locked into poorly performing shares because they’re part of an index.

According to the life insurance and pensions group, individual investors would be less able to diversify by investing outside the index and could therefore see greater volatility in their investments.

For new businesses looking to raise start-up funding, it could be made more difficult if most investment flows were restricted to established companies covered by share indices.

In addition, managers of businesses would face less accountability and may “fail to maximise the potential of their business”, knowing that shareholders would not sell shares that are part of the index which they are tracking, Royal London said.

Price competition amongst passive fund managers could also drive down the resource allocated to engagement with management to drive up company performance.

Piers Hillier, chief investment officer, Royal London Asset Management, commented: “There has been a flood of money into passive funds in the last decade as active managers have struggled to demonstrate that their higher charges deliver consistent value for money, and there is no doubt that passive investment forms a valuable part of any investment mix.

“But there would be dangers both to individuals and to the economy if the benefits of active management were to be lost completely and the dash for passive investment continued unabated. Individuals would have less choice and would be forced to follow the ups and downs of the stock market, whilst business start-ups would find it harder to raise money.”

He added: “When investing client money the right judgment is to look for targeted areas where simply following the market does not deliver the best result, and it is important that such active investment continues to be an important part of the UK investment landscape going forward.”

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