One of the most fundamental and enduring debates within the world of investments is over the issue of whether active fund management is better than passive fund management.
But what’s the difference? And is there any clear evidence to support either method?
Passive fund managers buy and hold portfolios that are designed to replicate the market, or part of it.
By buying each stock in an index, or a broad representation of the stocks in an index, passive managers generally deliver returns that match their index, so in theory at least there will be no nasty surprises.
A passive fund might track a particular sector, such as the FTSE 100 or the FTSE 250, or it might be the benchmark for a particular asset class, such as corporate bonds or property.
Passive investing advocates argue that markets are efficient – that is, that the market takes into account all the available information about any particular security and prices it accordingly. So they believe there is little room to take advantage of mis-pricing because prices already reflect true value.
However, the proponents of active management argue that the market is not completely efficient, allowing smart investment managers to beat the market.
Active managers seek to build portfolios that outperform a market benchmark, usually through a combination of stock selection and market timing.
In some years, some active managers will succeed in outperforming their benchmark, while others will fail. A small number beat the market every year.
At Plumb Financial Services, we believe that holding a combination of both active and passive managed funds will provide the best opportunity for longer-term investment growth. Increasingly, we use Multi-Manager or Multi-Asset funds for our clients, where you can invest into a single ‘fund of funds’. This fund then invests into a wide range of other investment funds or assets that are actively or passively managed by a professional fund manager to a given risk profile. This ensures that whilst your funds are still spread across a wide range of asset classes and different individual investment funds, the whole holding is controlled and managed by one overall fund manager who ensures that the risk profile of the fund is constantly maintained.
No single fund manager is the top performer in all investment sectors and most fund managers have their specialist sectors or a sector in which they are known to have particular knowledge or ability. That is where the Multi-Manager and Multi-Asset funds come into their own.
The overall fund manager is backed by a team of investment analysts and economists who provide a constant stream of up-to-the-minute performance data and information. This allows the fund manager to spot opportunities and to ‘cherry pick’ the very best investment funds and institutional assets from every investment sector for the fund that he or she runs.
Like many financial advisers, we offer our clients a series of Model Portfolios that contain Multi-Asset or Multi-Manager funds. The portfolios are all split 50/50 between a passive fund and an active fund within that investor’s given risk profile. Each fund will typically contain up to 20 other individual funds within it, giving the investor access to around 40 funds in an economical format. Although they will be invested in just two main funds, their portfolio will actually contain a wide spread of investment assets spread over several geographic areas, providing diversity and reducing volatility.
This approach gives the individual investor a balance between the passive and active positions, both of which are constantly managed to suit the identified risk profile of the investor at all times.
We believe that this gives an investor the best opportunity to benefit from both styles of fund management within their identified risk profile, thus increasing the chances of better returns over the longer-term.
In other words, having a ‘bit of both’ is probably the best investment strategy.
Nick Plumb is an Independent Financial Adviser and Practice Principal at Plumb Financial Services. Post your questions to Nick at Plumb Financial Services, Baylham Business Centre, Lower Street, Baylham, Suffolk, IP6 8JP, e-mail email@example.com, or telephone Nick on 01473 830301. Nick’s opinions and views in this column are provided only as a general guide and do not constitute personal financial advice. Any readers who require advice should contact Nick to arrange a complimentary initial consultation to discuss their own position and requirements. Plumb Financial Services is regulated by the Financial Services Authority.