When it comes to investing via investment funds, there are two main strategies - active management and passive management.
The debate about whether a passive or an active investment strategy produces a better return for investors has gone on ever since passive strategies came into being. As an investor, the two methods could have a major impact on your investments, so understanding the two different approaches is important.
An active strategy is one in which a fund manager makes investment choices on a regular basis, buying or selling holdings when they deem it necessary, often when they believe they can make a peak profit. An active strategy involves continual management and the fund managers use their extensive access to research in different markets and sectors. They also often meet with companies to analyse and assess their prospects before making a decision to invest.
Active management aims to deliver a return that is superior to the market as a whole or, for funds with more conservative investment strategies, to protect capital and lose less value if markets fall. An actively managed fund can offer you the potential for much higher returns than the market, if your fund manager makes the right calls.
A passive strategy meanwhile requires a lot less trading. In simple terms, money is invested into funds linked to indexes, such as the FTSE 100 or S&P 500. In more detail, it aims to reduce aggregate risk by eliminating specific risk. This involves investing each asset class in a portfolio to match, as closely as possible, the movements of a particular index.
Relying on the market to make your gains, passive investing is typically seen as a longer term strategy and, although it may sound easier than an active strategy from a management point of view, there is still a lot to do in terms of selecting the right funds and creating a well-balanced portfolio of asset classes that meet a client’s needs.
So which is best for you? On the active side, its advocates claim that such a strategy is the only way to generate better-than-average returns; the only way to ‘beat the market’. After all, passive strategies, though divested across indexes and asset classes, are by their very design market-linked. If the index that your fund is linked to goes up, so will your investments, but the opposite is true if the index falls. Your investment may never outperform the market but it will also never lose more than the market as a whole.
Passive strategy supporters, meanwhile, point out that active investment strategies cost more in fees, with these fees potentially impacting on the ability of the strategy to produce a better return. Proponents of passive investments also point out that active strategies can lead to increased volatility, due to the higher frequency of investment movements and the timing of those movements, which conversely also produce the potential for market-beating gains.
So it is not a simple choice. If you pick the right actively managed fund, you could potentially make much more money than you would with a tracker fund or ETF. Certainly there are some star fund managers who have built up reputations of consistent high returns and they can be worth the fees you pay for them.
An active strategy also means that you have somebody tactically managing your money, so when a particular sector looks like it might be on the up, or one region starts to suffer, the fund manager can move your money accordingly, to expose you to this growth or shield you from potential losses. Passive managers can do nothing but watch their portfolios decline. Arguably therefore, active investment is lower risk than passive.
In addition, some areas of investment are much better suited to active rather than passive management. Property funds, for example, buy commercial properties and pay returns based on rental income and increases in capital value of the properties. A tracker fund simply cannot do this and it may be valuable to invest in an actively managed property fund.
An active manager might also be useful in more specialised areas, such as technology, healthcare, smaller companies or emerging markets, where expert knowledge can help to seek out value.
However, with so many actively managed funds out there, knowing who will perform best in the future can be tricky. Yesterday's winners are often tomorrow’s losers and vice versa. This is where financial advice comes in.
So which strategy is right for you, as both methods offer value to investors? Whilst there is a lot to be said for the active management route, there is always the question of whether the long-term returns justify the additional costs and perceived risks. Many investors opt for a combination of the two strategies.
To discuss which investment strategy is best for you, your portfolio and your circumstances, talk to Kellands.