Deng Xiaoping once claimed that it didn’t matter if a cat was a black or white as long as it caught mice it was a good cat. To some extent the debate about passive and active funds has descended into polemical rhetoric reminiscent of the struggles between communism and capitalism. Opinions have become so entrenched that some advocates of one type refuse to consider using a member of the rival group. Such intransigence is not helpful to the people that really matter; the investors. They should be advised by those prepared to look at all the options. Moreover, the gap between the two groups is becoming harder to define as funds in both cohorts evolve to adjust to the new realities of the market place. Some active managers are cutting fees to compete with passive funds and some passive funds are not that passive. In a changing world the old labels are no longer so accurate.

To complicate matters new funds have been developed that are neither fish nor fowl and are hard to ascribe to either category and even harder to name. Is it best to call them active trackers, passive actives, blended, melange, mixed, process driven, asset allocation, crossbreed, crossover, mongrel, combination, compound, amalgam, mulatto or maybe just hybrid?

As in any debate it is always helpful to define terms before trying to resolve the issues. While many people think they know instinctively what an active fund is it is a lot harder to construct a definition. Besides, what actually do we mean by passive anyway?

A common description of an active fund is one that aspires to beat the market, which of course begs the question of what is “the market”. A widespread assumption is that it is the appropriate stock market index, typically the FTSE 100 or FT All Share. The first challenge here is to make sure the index is the total return measure so that it includes reinvested dividends and not just the simple capital index. As an aside it is worth pointing out that a number of structured products exploit this seemingly arcane difference to set benchmarks that the providers know they have a better chance of beating. They hope investors won’t notice them pocketing the dividends. Absolute return funds are especially good at exploiting such differences.

A minor point is…

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