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Active or Passive?

Investment

Which is Best; Active or Passive?

The Active v Passive debate is the financial services equivalent of the age old question of whether the Chicken or the  Egg came first; it is an argument which will probably never be resolved.

At Protect and Invest we can see the benefits of both the Active and the Passive investment style. In fact, we believe they compliment each other perfectly, and that's why the default option within the  Protect & Invest Portfolios for those who do not have a strong view either way is to have a 50:50 blend of both investment styles. However, we also offer fully Active and fully Passive options for those who do have a preference. The concept of Active and Passive investing is explained below.

The Difference Between Active and Passive

Active Investment

When most people think of an investment fund manager, they imagine a city professional staring at a screen of numbers yelling "buy" or "sell". It involves a human element of decision making; someone who is taking strategic decisions about whether to hold the shares of a certain company within the fund, trying to constantly achieve the optimum mix of shares and other assets to give their investors top returns. The human element in markets means that no fund manager will outperform year in year out.

Naturally, this extra involvement doesn't come for free, so actively managed funds are generally more expensive than their passive equivalent. If you have the right fund manager who is regularly outperforming, the extra cost may be worth paying for. But how do you tell whether you have a good fund manager? As you would expect, we of course carry out a great deal of qualitative and quantitative analysis to help us assess whether a fund is worthy of a place in your portfolio, and we can choose from any of the funds available in the marketplace. However in the absence of a crystal ball, we cannot predict whether a fund will continue to perform in the future. That star fund manager may retire, for example.

Passive Investment

Proponents of Passive investments argue that due to this human element there is no point paying the extra cost for a manager to try and outperform an index; you might as well just track an index at a much lower cost, safe in the knowledge that whilst you probably won't outperform the market, your investments are less likely to significantly underperform the market; thus giving you peace of mind that your portfolio performance will always be there or thereabouts. Choosing a passive fund usually starts with deciding which index to track, such as the FTSE 100.

To complicate matters further, there are different types of passive funds. The funds which will most closely resemble the index they are tracking are known as full replication. These are our favourite types of passive fund; they hold the same proportion of every share that makes up the index they are tracking. This is a simple but effective way of following an index. However, for smaller funds it can be so expensive to buy so many different shares that the charges would simply cancel out the lower cost benefit of a passive fund. As a result, these smaller funds will often buy a selection of shares to try and similate the market, but this of course involves decision making about which shares to buy; again introducing the human element and possibility of underperformance compared to the market.

At Protect and Invest we mainly use Vanguard for passive funds. The Vanguard Group launched its first passive fund in 1976 in the US, and investors worldwide now trust it to manage $1.8 trillion of assets. This gives them the sheer scale to offer full replication funds at a very low cost, allowing us to introduce the true benefits of passive investment into your portfolio; accurate index tracking with very low charges.

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