EUROPE- Passive management looks set to take off in Europe despite criticism that bear markets benefit active managers and despite a warning from Standard & Poor’s that the risks involved may be greater than investors realise.

Currently, European institutional investors passively manage only around 3% of their equity allocation, compared with 20% in the UK and 30% in the US, but levels in Europe will gradually to converge towards those in the US, say Oliver, Wyman and Company and UBS Warburg in their joint report “The Future of Asset Management”.

Passive managers are gaining ground as continental trustees begin to question active manager performance more rigorously, according to the report. The bear market has left many wondering whether the fees paid are justified.

Furthermore, the influence of state-funded pension schemes choosing large passive allocations and the creation of investor-friendly indices are helping to boost the cause of passive management. The report predicts that Europe’s passive management levels could see a 60% shift by 2006 towards the current US levels.

Standard & Poor’s, however, offers a word of warning. Passively managed funds, or tracker funds, are seen as attractive by investors as they offer the cheapest, easiest and lowest risk option. But investors using the method in order to avoid sector- or stock-specific risk could be doing the reverse.

Says S&P: “some 63% of the UK market is comprised of only 15 stocks. As for sectors, the FTSE is dominated by banks, pharmaceuticals, oil and telecoms, again some 60% of the market.”

Over the year to June 2002, S&P found that although the FTSE All Share Index dropped 14.2%, the average size of the 10 All Share tracker funds covered fell by only 11.7%. In contrast, the average size of the four funds tracking the FTE 100 fell by more than the 15.2% index fall.

Oliver, Wyman and UBS Warburg, however, views the poor diversification for which tracker funds are criticised as “inefficiencies of the index, rather than of passive management per se.”

For many managers, however, the age-old argument of whether passive management or active management is no longer valid.

“Investors are now using risk budgeting to design the investment portfolio most suitable to their needs. This normally means using a mix of active and passive strategies in a core-satellite set up”, says a spokesman for Barclays Global Investors adding “in the institutional market place we believe the active passive debate is dead.”