James Churchman, Head of Sales at Linear Investments, gives his thoughts on the one of the oldest running debates. Active funds or passive funds?
Primarily we are talking about this within the context of creating and managing model portfolios as part of a broader managed service. Financial planners will have developed a personal view through years of financial planning. This view will then translate itself into the central investment proposition on offer and often then become the “house view” of that adviser or firm. But how much thought do we put into the subject and is there a danger of becoming entrenched.
Passive Funds
Passive simply means reducing the buying and selling and letting wealth build long term with minimal interference. Passive Exchange Traded Funds (ETFs) are a vehicle to track an entire index or sector with a single security. Investors can buy and sell funds throughout the trading day, just like stocks on a major exchange. This provides great flexibility to execute a buy and hold strategy
ETFs trade like stocks, giving a liquidity advantage. Whereas many mutual funds trade once a day, ETF share prices fluctuate all day as the ETF is bought and sold.
Active Funds
Alternatively, an actively managed fund has a dedicated manager or team making decisions on the underlying stocks and allocation, and as opposed to an ETF, won’t track an index but instead will buy and sell specific stocks from within that index or sector.
So, the question is always, can an active manager outperform their index/sector and are they worth paying more for?
It’s been difficult for Active Managers to outperform the index on a gross level especially in the bull market; then take into account some of the fees active managers have charged it’s really hard on a net level to outperform their cheaper passive/ETF counterparts.
Of course, there is an argument too for active management. Although fees are higher than the ultra low passive fees, active managers can bring bigger rewards with the possibility of beating that particular benchmark (alpha).
I don’t always feel like it’s a fair argument and to some extent it’s a winless argument. Lots of people that sit in the passive camp always bring the argument around to cost, and as an access to beta you can’t argue with that. And as humans we are constantly looking for confirmation bias to support our own theories, whatever they be.
The better question, and it’s a question that we deploy here at Linear, is to try to determine which markets may need an active approach and then focus on the fund managers that have that expertise. Certain geographies and markets are subject to inefficiencies that can benefit from a manager actively selecting investments in order to avoid the pitfalls, and we’ve seen significant alpha and diversification added to portfolios from their inclusion.
Never be passive for passive sake nor active for active sake. Determine your asset allocations and then ask yourself for each allocation and each jurisdiction, which approach you feel would provide the performance you need.
Better still, to outsource to Linear’s managed portfolio service, and we’ll deploy our expertise on your behalf!
There has been a lot of growth and creativity in the market and you can now consider many more options than just trading on the S&P500. There is a ‘sin’ EFT where companies invested in create over 50% of their revenue from alcohol and tobacco and the like and at the other end of the spectrum a vegan ETF. This allows flexibility for the investor accounting for their lifestyle beliefs as well as their appetite towards risk and reward.
Linear’s Discretionary Fund Management team offer both passive and active and blended propositions to our clients.
If you’d like to know more about Linear’s investment solutions, please contact jchurchman@linearinvestment.com