Investing - Go Active or Passive?
For years there has been a debate amongst investors whether to put their monies into actively managed funds, index tracking funds or something in between called Strategic Beta Funds or alternatively ‘Smart Beta’. In the last couple of years there has been a growing demand for passive funds. This move can be explained by regulatory changes that are currently ongoing; the emphasis on the overall cost of investing or lower turnover strategies in line with desired low volatility. Nevertheless, taking into consideration Vanguard’s top 25 funds by assets, then 7 among them are reported as actively managed funds suggesting there is no uniform answer to this dilemma.
We therefore feel we should look closer at the specific criteria that play a vital role in a decision making process of choosing whether to go active or passive.
1. What is the prime aim of the investor?
If you are an investor satisfied with modest returns and relatively low volatility, then index tracking funds appear to be the right choice. However, if you consider yourself more bullish and wanting to beat the benchmark index, then you should go for actively managed funds. Be mindful that many active funds do not beat the benchmark so do your research or use an advisor/analyst who will do this for you.
2. Is risk control a priority?
For Investors who wish to control risk, they should favour actively managed funds with an emphasis on downside protection. Skilful and thoughtful active managers can prevent their assets from falling by building cash or avoiding overheated market segments. Good active management can consequently lower volatility down relative to index tracking funds. Nevertheless, not all managers follow this defensive strategy and therefore it is important to carefully pick active managers. Indeed, do not assume that active management is always equal to good downside protection. During the 2008 downturn, actively managed funds did not, in aggregate, deliver significantly smaller losses than the market.
3. How satisfied are you with your current track record?
This section is dedicated to those who have already relied on active management in the past. Whether you pick your funds individually or base your choices on the advice of investment managers, you should evaluate your track record relative to a blended benchmark that fits your asset allocation. If it turns out that you have not added any value by selecting individual funds then you may be better off steering part or your entire portfolio towards the index tracking funds.
4. How patient are you?
Trying to beat the market index requires a lot of patience. There may be a period when you will be facing large performance swings between your portfolio and the market index. To beat the market you should select a strategy that has to be appreciably different to its benchmark and to its peers. High conviction and idiosyncratic strategies have the potential to deliver market-beating performance over long periods of time. However, they can also lead to sustained periods of underperformance relative to its peers or index.
To sum up, due to regulatory change; emphasis on the overall cost of investing, and lower turnover strategies with low volatility, demand for passive funds seems to be growing. Nevertheless, experienced managers claim that it is not of that importance to choose specific percentage exposure to actively and passively traded funds. What is more important is to be very selective when choosing funds and make sure they are aligned with the individual’s financial goals.
At Astra we use a mixture of best in class actively managed funds and also passive funds. For more information please do get in touch.