Harry Reeves, Head of UK Wholesale at Franklin Templeton, explains why combining quantitative models with qualitative insights could help investors capture the benefits of both passive and active investing.
What do you get if you cross a quantitative fund with qualitative insights? Don’t worry – this isn’t the opening line of a bad joke. The simple answer is that you get a means of merging passive management with its active counterpart.
Product providers have been quietly wrestling with this challenge for some time. While the age-old “passive versus active” debate continues to rage, logic dictates there ought to be a measure of appeal in strategies that bring together the best of both worlds.
The case for such thinking is especially compelling at present. We need look no further than the UK market to understand why.
According to the Investment Association, retail funds under management (FUM) in index trackers reached £383.7 billion in 2024. That’s a record – one that reflects year-on-year growth of 18.5% and accounts for more than 25% of all FUM [1].
On the institutional side, meanwhile, trackers also account for around 25% of assets under management. This isn’t a peak – the figure has exceeded 30% in the past – but it’s still substantial
[2].
Of course, a major reason why active managers in the UK have been under mounting pressure in recent years is cost. Both the Retail Distribution Review and Consumer Duty placed extra emphasis on value for money, allowing lower-margin trackers to gain an ever-firmer foothold.
In tandem, macro dynamics have played into many passive investors’ hands over an extended period. Low interest rates and plentiful liquidity prevailed for the better part of two decades.
Against this benign backdrop, maybe above all, US exceptionalism offered an agreeably straightforward play. There was much to be said, for example, for simply tracking the S&P 500 and revelling in the rise of the Magnificent Seven tech titans.
Yet the picture has undoubtedly shifted of late. Uncertainty and volatility have delivered a timely reminder that the only way to beat the market is to differ from it and that what happens at the company level is often the key to generating additional alpha.
As a result, broader appreciation of active management’s role in both enhancing returns and controlling risk is enjoying a renaissance. While it may never have gone entirely out of fashion, qualitative analysis is earning new admirers.
This brings us to the space between passive and active. Specifically, it brings us to the question of how that space might be filled. In our opinion, this is where the innovative use of factors enters the reckoning.
Uniting width and depth
Courtesy of Modern Portfolio Theory and the Capital Asset Pricing Model, it was once held that only one factor, market risk, should shape portfolio construction. It’s safe to say a lot has changed since then.
Amid criticisms that the single-factor model failed to adequately explain actual returns, new analytical frameworks soon arose. Consequently, factors such as quality, value and sentiment have been widely employed for decades, with hundreds more available for consideration.
Yet precious few – if any at all – can truly be said to help close the gap between passive and active. In order to achieve this goal, we would need to somehow combine the predictive power of systematic models with the expertise encapsulated in bottom-up research.
One option is what might be called a “conviction” factor. Its aim would be to identify more idiosyncratic return drivers by drawing on active managers’ insights into individual companies’ distinctive attributes. In effect, it would turn fundamental analysis into a factor.
Leading to “conviction scores” for all the equities in a given investment universe, the overall process would remain systematic. Ideally, it would capture both passive’s width and active’s depth – and, crucially, it would be capable of doing so at a competitive price.
Our own back-testing indicates a conviction factor could account for a significant percentage of outperformance over time. Depending on the market, it would likely be second only to quality in determining a fund’s risk-and-return profile.
Would such a strategy “shoot the lights out”? No. The space between passive and active requires a prudent mix of additional alpha and risk mitigation, so tracking error would need to be tight.
Yet having this sort of blend at the heart of a portfolio could free up “risk budget” that might be used elsewhere. With a core strategy seeking above-market returns while limiting deviation from underlying indices, active funds that are more specialised and targeted could be used to strive for outperformance.
Even having implemented such an approach in some of our own core strategies, we don’t see this as a revolution per se. After all, it doesn’t need to be a matter of replacing existing products: realistically, it’s more a matter of adding to and complementing them.
In our view, though, it does constitute an important evolution. Going forward, providers could increasingly find novel ways of utilising active managers’ skills to help avoid the curse of “technical underperformance” – which is essentially what passive investors get from a combination of benchmark replication and fees.
To return to where we began: this is no joke. The “passive versus active” debate has never been a bundle of laughs in any event. But perhaps we’re getting a little closer to a punchline.
Sources:
[1] See, for example. Investment Association: Investment Management in the UK 2024-2025, October 2025 – https://www.theia.org/industry-policy/research/investment-management-survey-files.
[2] Ibid.
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The writer’s views are their own and do not constitute financial advice.
This information should not be relied upon by retail clients or investment professionals. Reference to any particular investment does not constitute a recommendation to buy or sell the investment.
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