Is Active or Passive Investment Management Better?

One of the perennial debates in the investment industry is the relative merits of Active vs Passive Investment Portfolio Management.

Proponents of the passive philosophy believe that over the long term individual fund managers cannot "beat the market" and that by simply investing in an index of the market you will get the best returns.

Proponents of the active approach believe that over the long term you can outperform the market by selecting individual company stocks or securities and ignoring the index.

There are zealots in both camps and there a whole lot of people sitting somewhere in between weighing up the merits of the two arguments.

The passive approach is supported by the "evidence" that on average most fund managers don't outperform the index. And as they are being paid for the privilege of managing your money they are a bad idea.

Click here for >> An Argument for a Passive Investment Strategy

But does the evidence supporting passive management actually mean anything?

Fund managers, whether they work for institutions or retail investors used to dominate the investment markets by sheer weight of money, they were the market. In the 2020s index funds (passive) attracted a lot of money and now hold perhaps as much as 50% of the total market.

The index is the measure used to measure the return of the market as a whole. All the passive investors by definition will achieve this return, so they don't affect the average, they are the average. The active managers will achieve higher or lower returns depending upon how their "picks" have performed over the period compared to the index. Average them out and you get the market of active investors, add them to the passive managers and you get the index. Of course it's not quite that simple but pretty close.

So by saying that on average active fund managers don't outperform the market is like saying that on average most rugby kickers don't score more than the average number of kicks in a season, the average goal shoot doesn't score more than the average number of goals in a netball game, or the average cricket batsman doesn't score more than the average number of funds. No of course not because on average the average is the average!

However like sportsmen the key to getting better than the average result is picking the right player or fund manager, and of course that's easier said than done.

You will generally pay higher fees if you invest with a passive manager. An active manager has considerably more expenses as they have to pay people to do the research.

You can read recent analysis on this topic from the well regarded research house Morningstar  here >> https://www.morningstar.com/business/insights/blog/funds/active-vs-passive-investing. The latest figures say that in some areas, notably the massive US Equities market, passive has got better returns than active. However active strategies are ahead for bonds, real estate and small cap funds.

Click here for >> An Argument for Active Investment Management

Perhaps a "blended" approach is the way to go, hedge your bets and put some with a passive manager or buy ETFs and invest some with an active manager.

Active vs Passive - The Debate is Over! (It might have been in 2015)

The debate over active vs passive investment has been raging for over 25 years. A 2015 study by the Petersen Research Institute (PRI) in Australia concluded that for Australian super funds, active management added value net of fees, and the more of a fund's risk budget is allocated to manager skill, the better the outcome for fund investors.

It provided evidence to support the view that there are investment managers out there who can and do outperform the market over time and provide investors a better than average return after costs.

You can read the research paper here: PRI Active vs Passive Research Paper

One of the key points made in the paper is that institutional investors don't invest in the 'average' managed fund. If you have the resources to identify and select the best active managers then your clients' net of fee outcomes will be better than in a passive strategy. But that paper was prepared in 2015.

But of course few retail investors have the time, resources or know how to identify and select the best active managers. That's where we come in. At Bay Financial Partners we are constantly looking at the available options and trying to select those suitable for individual investors. It may be that an active approach isn't for you, and that's fine. But if you want to get better than average returns an active investment manager is worth considering.