Active vs. Passive. When and Where?

HSVX

I am interested to know what everyone's thoughts are on the active vs. passive debate. When do you think passive wins out and when should you look for funds ran by someone who knows what they are doing?

I feel like the general consensus is that passive funds are great for things like getting exposure to mature markets like North America, Europe, Japan (which could make up the bulk of a portfolio), and then active funds are preferred for emerging markets (including South America, the rest of Asia etc.), smaller companies, property, and specialist areas like technology, biotech, natural resources.

I would be interested to know what all of your thoughts are on this? Do you think a passive solution really can cover everything or do you prefer to mix and match? If you do veer towards the active side for some investments, what are you looking for in the funds you select?

N1AK

HSVX wrote: »

I am interested to know what everyone's thoughts are on the active vs. passive debate. When do you think passive wins out and when should you look for funds ran by someone who knows what they are doing?

In my opinion active funds are useful when/if you are confident that you can pick an active fund that will outperform the underlying market by more than the premium you're paying over a passive fund.

Personally I invest in developing markets in two passive funds. It may well be true that their are some fund managers who can reliably outperform the market there, but I haven't seen any compelling evidence and I don't think I have an insight that lets me reliably pick a winner.

redbuzzard

The received wisdom seems to be that there is more scope for managers to add value in less researched markets, and another reason to think active might be better in EM is that standards of corporate governance can be very variable; alo many firms have significant family shareholdings - they may not always be run in the way you would expect a public company to be.

As well as the scope to outperform, there is also the opportunity to go the other way. The difficulty I have is in picking the right manager!

BLB53

Most active funds fail to consitently beat the index over the longer periods - admittedly, some managers do manage this but it is difficult to pick them out at an early stage.

You therefore have maybe a 5% or at best 10% chance of selecting a long term winner from the thousands on offer or a 100% of matching the index with a low cost tracker.

Warren Buffett suggests most amateur investors will be better off with a low cost index fund.

The best returns from the managed sector are smaller companies, so there will be more logic to including these alongside a portfolio of mainly globally diverse trackers.

Linton

It all depends on how big your portfolio is and what you want from it. For example if you have a small number of £Ks and have no specific objectives then you may as well put it all in a global or multi-asset fund. The fund itself may not be passive but its constituents could well be.

On the other had if you want steady income from a large pension drawdown pot then there is really no choice - passive funds are not very effective at providing a relatively secure above average steady income.

As your portfolio gets larger you may find it both interesting and worthwhile to take a greater interest in what your money is actually invested in to maximise your diversification and to focus on areas you feel could be relatively lucrative. If you can find a managed fund which matches your objectives it is clearly better than a passive one which doesnt.

All this talk about managed funds not beating the index is most misleading. There are indexes covering many different investments areas with no matching passive funds and many different areas with no meaningful index.

The first thing to do when constructing a portfolio is to decide its objectives and what you are going to do to achieve the objectives. Only then can you ascertain which funds together will do the job. These funds could be active or passive - which you choose is a secondary concern.

HSVX

Linton wrote: »

It all depends on how big your portfolio is and what you want from it. For example if you have a small number of £Ks and have no specific objectives then you may as well put it all in a global or multi-asset fund. The fund itself may not be passive but its constituents could well be.

On the other had if you want steady income from a large pension drawdown pot then there is really no choice - passive funds are not very effective at providing a relatively secure above average steady income.

As your portfolio gets larger you may find it both interesting and worthwhile to take a greater interest in what your money is actually invested in to maximise your diversification and to focus on areas you feel could be relatively lucrative. If you can find a managed fund which matches your objectives it is clearly better than a passive one which doesnt.

All this talk about managed funds not beating the index is most misleading. There are indexes covering many different investments areas with no matching passive funds and many different areas with no meaningful index.

The first thing to do when constructing a portfolio is to decide its objectives and what you are going to do to achieve the objectives. Only then can you ascertain which funds together will do the job. These funds could be active or passive - which you choose is a secondary concern.

So let's say in this case you are not going to need money from the portfolio for a very considerable amount of time (20+ years) and all you are trying to achieve is maximum capital growth. How does that change your perspective?

I am well aware that different people have different needs for their investments etc., but I want to strip all of that out and talk about whether active vs. passive management is something that should be looked at from different angles depending on what sectors you want to invest in.

232607

I'm more of a fan a passive funds & have my portfolio with 72% passive & 28% active. In truth I would be 100% passive but for the fact you can't really do active in certain sectors life property or under valued funds.

Having said that I have read Tim Hales book (smarter investing) where he virtually condems the active approach.
The over riding factor in the book is that only 1 in 5 active fund managers historically beat the market which is what passive would achieve less very small fund charges. This is by virtue of the fact that active funds are more expensive thus they have more work to do.

It also helps in that once you have passive portfolio with the right mix, you can more or less just let it ride other than a bit of re-balancing now & then.

Just my take on things but I'm sure others will have different views.

Regards

N1AK

Linton wrote: »

All this talk about managed funds not beating the index is most misleading. There are indexes covering many different investments areas with no matching passive funds and many different areas with no meaningful index.

No it isn't. Clearly you can't compare passive funds to active funds in a market where only one or the other exists; I think most people will have correctly assumed that. There's not exactly a lot of point debating the merits of passive vs active with regards to markets that don't have both.

HSVX

N1AK wrote: »

No it isn't. Clearly you can't compare passive funds to active funds in a market where only one or the other exists; I think most people will have correctly assumed that. There's not exactly a lot of point debating the merits of passive vs active with regards to markets that don't have both.

Agreed.

Like I said there is a general consensus that with developed markets it is best to use passive trackers, and that is the view I take.

I am interested to hear about instances where you would consider using an active fund and why.

Linton

HSVX wrote: »

So let's say in this case you are not going to need money from the portfolio for a very considerable amount of time (20+ years) and all you are trying to achieve is maximum capital growth. How does that change your perspective?

I am well aware that different people have different needs for their investments etc., but I want to strip all of that out and talk about whether active vs. passive management is something that should be looked at from different angles depending on what sectors you want to invest in.

You cant "strip it out" as the sectors dont correspond to the different needs an investor may have. For example as I am retired I want EM income as a diversification from my UK shares. Passive funds cannot provide this. And there is no point in saying that the fund I choose doesnt beat the (or one of the several) relevant indexes over the long term because I am not after maximum capital growth over the long term. Actually I may be more interested in wealth preservation, not something passive funds major on.

Let's take your example of an objective of long term capital growth. You could choose to invest broadly in large companies in the US, Western Europe, and Japan. If that's what you want to do I see little point in not going passive. Though you do have to be careful. A true global index based passive fund would have 50% or so US. Is that what you want? It is after all "the market which cannot be beaten". Fortunately there are broadly passive funds with some manager high level tweaking - eg the Vanguard LS series which have a rather more even geographical split.

However there are other things you can do. I rather fancy investing in small companies across the world - difficult to do with a passive fund. Especially as index funds automatically invest in the largest companies in their index. Going for large small companies seems on odd thing to do.

EM and the related Far East/Pacific ex Japan sectors are another case in point which have outperformed the Global Index over many years. The Vanguard Pacific fund is rather keen on Australian miners and bankers. Perhaps not quite what you had in mind when you decided to invest in those sectors.

To summarise, you need to look at what a fund invests in and decide whether the asset allocation meets your requirements. It's foolish in my view to make your primary decision on whether a fund is active or passive - the difference is marginal compared with the other factors.

Linton

HSVX wrote: »

Agreed.

Like I said there is a general consensus that with developed markets it is best to use passive trackers, and that is the view I take.

I am interested to hear about instances where you would consider using an active fund and why.

Generally: whenever you want something different to the index asset allocation.

For example sub-sectors of developed markets. eg small companies, particular industries, income vs capital growth. In all of these you have an asset choice criteria other than company size.