The Case for Active and Passive Management
With the proliferation of active and passive funds being offered in the markets, we hear endless debates from both camps on why we should choose one path over the other. This debate usually reaches intense levels during extreme market points when one style tends to outshine the other. For example, when global markets rise over time and almost everything we buy makes money, it is easy to argue for a low cost, passive method to just ride the upward trajectory. When markets decline however, there’s usually a strong case for active management to enable downside protection.
The problem with arguing against either of these camps is that both have a strong conviction for their style and often, the conviction from each side is persuasive. The below chart shows the amount of active fund managers that beat passive index managers. During a strong market, it seems to be clear that many active managers struggle to beat their respective passive index but during a downturn, their worth comes to life and many tend to do better in protecting your investments. It seems clear that active management does pay over time. What is less clear is how we choose those managers that do outperform consistently.
Source : Forbes, March 2015
What is our view?
We all know that no one can be everything to everyone. Some of the arguments for and against each are very academic and will need a thesis to explain. However, in summary, our experience shows that when the broader market rises strongly and even poor quality companies rise, there is very little information or time advantage to enable active management an edge (confirmed in the above diagram). Due to behavioural biases, when many active participants decide to leave and choose an index, things usually turn, providing opportunities for those active managers who have stuck around. This is where most would feel the fees paid to active managers are worth their while.
At the end of the day, we believe that protecting the downside is a critical point in managing money and why active managers need to get paid. However, every style has its day and the debate amongst investors on which style is better will no doubt continue.
One of our jobs is to find these “best of breed” active managers, filtering them to only the best and understanding how to allocate them into our portfolio construction process. Hence, we have created a successful “absolute return” portfolio that combines various strategies to protect you better when markets fall.
Likewise, we understand some clients have a very strong adversity towards cost no matter what the reward. As such, we have also recently created a very low cost option using passive investments.
To determine which investment path and style is most appropriate for your portfolio, please do not hesitate to discuss this with your Financial Decisions adviser.
Disclaimer: This publication has been compiled by Financial Decisions (AFSL/ACL Number 341678). Past performance is not a reliable indicator of future performance. While every effort has been taken to ensure that the assumptions on which the outlooks given in this publication are based on reasonable data, the outlooks may be based on incorrect assumptions or may not take into account known or unknown risk and uncertainties. Material contained in this publication is an overview or summary only and it should not be considered a comprehensive statement on any matter nor relied upon as such. The information and any advice in this publication do not take into account your personal objectives, financial situation or needs. Therefore you should consider its appropriateness having regard to these factors before acting on it. While the information contained in this publication is based on information obtained from sources believed to be reliable, it has not been independently verified. To the maximum extent permitted by law: (a) no guarantee, representation or warranty is given that any information or advice in this publication is complete, accurate, up-to-date or fit for any purpose; and (b) Financial Decisions nor its employees are in any way liable to you (including for negligence) in respect of any reliance upon such information or advice. April 2016
Contact: Financial Decisions PO Box 484 Mona Vale NSW 1660, T 02 9997 4647, F 02 9997 7407