The Active vs Passive Management Investing Debate

The Active vs Passive Management investing debate

What is active fund management?

An active fund management is a more hands-on approach to invest and requires a manager to act the role of a portfolio manager, making decisions about how to invest the fund’s money. The goal of active fund management is to beat the stock market’s average returns and take full advantage of short-term price fluctuations. Active funds involve a deeper analysis and expertise of stock market knowledge. Therefore, it requires an individual portfolio manager, co-managers or a team of analysts actively making investment decisions for the fund.

This portfolio manager usually oversees the team of analysts and selects investments based on an independent assessment of each investment’s worth by paying close attention to market trends, shifts in the economy, changes to the political landscape, and factors that may affect specific companies.

This data is used to time the purchase or sale of investments in an effort to take advantage of irregularities. Active managers claim that these processes will boost the potential for returns higher than those achieved by simply mimicking the stocks or other securities listed on a particular index.

The success of an actively managed fund depends on combining in-depth research, market forecasting and the experience and expertise of the portfolio manager or management team.

What is passive fund management?

Referred to as an index fund management, the strategy of passive investing requires passive managers to simply own all stocks of a given market index and then create a portfolio to track the returns of the particular market index or benchmark as closely as possible.

With no intermediary nor management team, passive fund management is the opposite of active fund management with its aim is to track the market with various investing strategies rather than beat it. In contrast to active funds, this strategy typically gets good diversification, low turnover and low management fees.

Therefore, index funds are easy to understand and offer a relatively safe approach to investing in broad segments of the market. Generally, passive fund management limits the amount of buying and selling within a portfolio, making this is a more cost-effective way to invest than active fund management.

What is the difference between active and passive fund management?

There are 3 main differences between the two different investment strategies:

1. Strategy & Management Strategy. These approaches differ in how the account manager utilises the investments held in the portfolio over time.

• • Active portfolio management focuses on outperforming the market compared to a specific benchmark while passive portfolio management aims to mimic the investment holdings of a particular index.
  • Active investing is flexible and therefore can invest in any stock desired, allowing them to hedge their bets using various techniques such as short sales or put options.

• • Passive investing is more transparent; it’s always clear which assets are in an index fund. However, investments are limited to a specific index or predetermined set of investments with little to no variance.

2. Fees:

• • Active investing requires ongoing research to try and determine the best stocks so has high operating expenses.
  • Passive investing requires no management team nor manager so have ultra-low fees.

3. Returns:

• • Active investing can bring bigger returns but with a bigger risk.
  • Passive investing rarely beat the market so only generates small returns.

Are passive funds better than active?

Generally, passive funds are more popular than active funds for a variety of reasons.

Firstly, for financial reasons: passive funds are cheaper and they do not include the flat fees of active funds which are very expensive regardless of the fund’s performance. Additionally, every time an active fund sells a holding, the fund incurs taxes and fees which diminish the fund’s performance.

Active strategies tend to only benefit investors in certain investing climates and therefore many active managers fail to beat the index after accounting for expenses, so passive investing has typically outperformed active strategies.

For example, this year, 9% of active stock managers failed to reach their benchmark and the cheapest funds succeeded more than twice as often as the priciest ones. So, when specific securities within the market are highly correlated or moving in union, passive strategies are always more successful and have fewer risks than active investments.

In the current 2019 market upheaval, active investing has become more popular than it has in several years, regardless of this, passive is still a bigger market. Both styles of investing are beneficial but passive investing is more popular in terms of the amount of money invested. Additionally, passive investments have made more money historically. Ultimately, it comes down to what the client is looking for, so if they want a low-risk and low-cost investment, a passive portfolio or passive fund management will make more sense for that client.