Active or Passive Investing – which is better?

In the past couple of decades, passive investing has become the strategy of choice for many investors, who are satisfied by duplicating market returns instead of trying to beat them. However, most investment advisers still recommend actively managed portfolios for a substantial element of their clients’ portfolios. Read about the benefits of active or passive investing here.

Active Investing:

Active management might best be described as the challenge to apply human intellect to find additional returns in the financial markets. Active fund managers complete extensive research to help them select the shares they think will perform well in the future. They use their own fundamental techniques and procedural analysis to judge which investments will perform well for them within their given portfolios.

An active fund manager will review certain stocks and bonds regularly, for example concentrating on larger companies in Europe (‘blue chips’), and then actively deciding which to keep in their portfolio and which to remove. In short, their objective is to make a return for their clients, and to provide better returns than they would have done if they simply accepted normal market returns.

Passive Investing:

Conversely, passive fund managers invest in broad sectors of the market, and exactly like active investors, they also want to make a profit for their clients, however, and this is the key differentiator, passive manager’s accept the average returns the various asset classes produce over-time.

The passive fund manager generally aims to do this by investing in similar shares to the benchmark (the S&P500 for example) in order to mirror the market as a whole fully, or through partial / mirror replication of the market. Passive fund managers also tend to make little use of the information active investors seek out (company earnings, debt, costs, management structure, product pipeline, R&D etc.).

How do the investing styles compare and contrast?

  • Control – active manager’s vigorously select the stocks that they want to invest into, whereas passive investors generally have to follow the broad sections of the market;
  • Costs – as active manager’s tend to buy and sell their stocks on a regular basis, they tend to be more expensive than passive investments;
  • Transparency – passive funds are generally very easily understood, as they are a comparatively safe approach to investing in certain, broad sections of the market. On the other hand, active managers can choose numerous stocks that meet with their investment criteria and buy and sell them as they see fit. It can sometimes be difficult for investors to keep track of the exact stocks they hold within their active portfolio at a point in-time.

So, which type of investment style should you choose?

In my opinion, there’s no definitive answer, as both sides have their qualities. The issue is that investment returns are the consequence of several unpredictable factors, such as social, political, technological, emotional and other factors effect market prices and cannot be foreseen in advance. There are also certain situations where active funds might be the only choice. For example, if you’re looking for specialist investments such as a particular industry, strategy or for certain asset classes such as European property, a passive fund in this sector might not exist.

And so, the answer for me is simple – it’s almost certainly best to have both strategies available to you and to tailor your portfolio’s on a bespoke basis. Analyse both strategies at all times, and employ them when you feel they may best meet your investment goals.

Gerard O’Brien LL.B LL.M CFP® QFA is a Certified Financial Planner and the Owner of Heritage Wealth, a Financial Planning practice based in Main Street, Midleton, Cork. For more information, contact Gerard at gerard@heritagewealth.ie www.heritagewealth.ie