Good outcomes, however, require a robust approach to value for money assessments, if not by you then by your investment solution provider. Generally, these will include both quantitative and qualitative considerations. But does the use of passive funds make the task more straightforward? Not necessarily.

Qualitative research is more commonly associated with active funds – but it’s important to spend just as much time looking under the bonnet of passive funds as well, because they aren’t all created equally.

1. Fund domicile and tax treatment

It is important to be aware of the withholding tax treatment of the index variant being used by a passive fund. There are benefits to UK investors accessing certain exposures via UK domiciled funds, as opposed to using cross-border domiciled funds distributed in the UK. This mainly applies to US, Global, Japan and to some extent emerging market exposures.

2. Index replication and tracking error

Understanding a fund’s benchmark index is often used as a guide to how it invests. However tracking an index tightly is not necessarily easy or cheap. Some stocks may be less liquid for example. Many passive funds in fixed income markets, where there can be thousands of bond issues in an index, use “stratified sampling” as a means to try to replicate the index at a lower cost. A number of passive equity funds use “optimised replication” for similar reasons. Inevitably, therefore, there will be a trade-off between tracking error and the cost of investing.

3. Charging policies

Look carefully at charging policies in order to understand what a customer may incur, because ther can be significant differences in fund group policies. OCFs are occasionally capped, for example, but usually vary. With passive funds, as with active funds, the OCF will not include the Transaction Charge which, given the lower OCFs of passive funds, will represent a larger proportion of all the fund-related charges. If you want a reliable, combined figure, look for the MIFID II charge.

4. Fund pricing and valuation timing

Another source of tracking error for a passive fund versus its index is where there are mismatches in the times that a fund is priced and when stocks in the index are priced. Many passive fund providers use custom or midday benchmarks which adjust valuation times in an attempt capture market opens and close in different markets. Many will also have global trading desks that allow 24-hour trading in order to capture fair prices.

For an in-depth assessment there are other areas to look at such as how passive funds deal with investor dilution (full swing pricing or partial swing pricing for example), or their stock lending policies. One other area to emphasise here, though, are the individuals running the fund and the decisions they take. Large, global teams are often involved, and its thorough qualitative as well as quantitative research and that enable proper scrutiny.

We’d like to conclude by closing the bonnet on the detail of passive funds and looking at value for money from a broader perspective.

Undoubtedly, alongside the cost advantages of passive funds versus active funds is the fact that they help shift the adviser/client conversation away from discussing funds and instead talking more about market trends and events. This may free up time that’s better spent focusing on the customer’s own financial priorities.

But bear in mind that with active and passive funds alike, a value for money review of your investment solutions will be strengthened by a robust, repeatable research and selection process – it really does make a difference.

Jon Lycett is key accounts manager at RSMR and Olga Baron is investment research support manager at RSMR

Source: Professional Adviser