Active vs Passive

JohnWinder

We need to be careful of illogical thinking here. Firstly, 

  They both replied that although passive funds had done well in the last ten years, that would not necessarily be the case in the future

We can have our own views on how well active or passive might do, but the IFA’s didn’t commit to any probability estimate, only that something was possible. Surely, that has to be the case, by the definition of ‘possible’ and ‘not necessarily’? They don’t even specify what ‘future’ is; they might have been thinking ‘1 year’ which is irrelevant for an investor but allows their statement to be easily defensible. The didn’t even suggest active would be better from now.  Basically, their statement is sufficiently meaningless for us to dismiss and ignore it, yet you’ve become worked up enough to share your concerns, because you’ve perhaps illogically taken it to mean there might be something of benefit/value in active investing from now.  Nothing in those IFAs’ statements changes what we’ve known for a long time about active vs passive investing, so relax. As to Ukraine, interest rates, covid etc, we’ve had Balkan wars before, interest rates at varying and various levels, bird flu and SARS, so there’s nothing particularly new about now (except for recent negative interest rates), only the names have changed.

been found to perform at least as well.…..chance that passive investing will be riskier …

Next, are you confusing ‘risk’ with ‘performance’?

‘Perform’ has something to do with returns; risk has a lot to do with swings in price, as well as not meeting future spending needs. An index fund’s value will swing around as the market swings around, closely matched. An active fund will swing just as much if it’s a ‘closet’ tracker (in which case what’s the point of paying higher fees?), or swing a lot more if it’s a high conviction fund far removed from reflecting the index (so, it’s riskier by that definition), or swing less than the index fund if the active fund holds only a few very stable securities (thus, less risky in that sense). But none of that changes the history of how well active and passive funds have behaved as evidenced by the SPIVA and Morningstar and other analyses.

IFAs are not investment managers.

If IFA’s are not investment managers, and it’s not because they can’t be bothered, then anything meaningful they say about investing might be just talking out of turn.

Cus

Go passive if you want market returns, go active if you want a chance of beating average. 

bostonerimus

Cus said:

Go passive if you want market returns, go active if you want a chance of beating average. 

...or making less than the average, maybe a lot less than the average. If your financial plans require you to get above average returns then IMO you need to adjust your plan as you will be taking on unacceptable levels of risk.

Swipe

https://www.youtube.com/watch?v=ltuqXTwWsZ8&t=274s

Linton

 Most replies on this thread are using the argument that passive investing proves higher long term returns on average and so must be superior to an active strategy.  This argument ignores the possibility that maximum long term returns may not be one’s primary objective.

As a retiree with increasing dependence on steady inflation linked income from investments my objective is sufficient short, medium and long term returns at minimum risk. Doing this requires careful attention to asset allocation. It is unlikely that index fund will provide the best solution since their composition is strongly influenced by investors with different objectives, in particular those seeking large long term (or even short term) returns  by investing in a restricted range of speculative opportunities.

With careful choice of individual active funds it is possible to achieve an overall allocation pattern that is compatible with one’s objectives.  Doing this with index funds is difficult because the only way to adjust an over allocation downwards is to buy more individual funds that invest in everything else which becomes impractical if one wants to cover multiple factors (country, size, sector, value vs growth, income).  This is easier with active funds because they provide a much wider range of different factor allocations.

So far all discussions seems to be based on 100% equity investing. ISTM that a fixed broad allocation  of bonds as provided by passive bond funds is totally inappropriate for meeting the objectives for which people generally buy bonds as recent events have shown. Better to buy individual bonds or active funds that make extensive use of bonds to achieve their objective.



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Nebulous2

Beware of believing somehow you are a Midas. If fund managers with access to more information than me, and time to study it, struggle to beat the index, then what chance have I?

We invested £80k in March / April 21. 4 full ISAs across two tax years. I struggled with the responsibility of having a lump sum to invest, which is the case with many relatively inexperienced investors asking about it on here. 

I really couldn't get my head round the 60% or so of a global tracker that was invested in the US, so I decided to go for some active to reduce that.  £30k each went into global trackers with £10k each in active funds. I picked a mix, some Europe, some Japan, UK smaller companies, UK mid-caps. 

Not a single one of the active funds is beating any of the global trackers. Most of them are still under water, while the trackers are not. In one spectacularly poor choice a UK smaller company fund I put £2k into was down 48% recently. Last time I looked it was not just bottom quartile, but the bottom  fund in its sector, 248th out of 248 over 1year. 

One of the worst things is that it was one in my wife's name, so every time she logs into Fidelity I am reminded of my lack of judgment. 

I've decided the people on here who cautioned me against fund-picking at the time were right, and active funds aren't for me. 

noclaf

I use passive across the vast majority of my investments and it suits me just fine. My current work pension which is relatively low in value, a bit more experimentation there as I am using both an active and passive equity fund alongside each other....0.345% difference on fees..... will monitor and see how they perform but I suspect as the value of the overall pot grows i will end up moving the whole lot into the cheap passive fund with fee of 0.165% which is v reasonable for a work pension fund (IMO). It's also at the higher pot values that those fees will bite more on the pricier active funds...unless the actives sufficiently out perform the passives!

Linton

Deleted_User said:

Linton said:

 Most replies on this thread are using the argument that passive investing proves higher long term returns on average and so must be superior to an active strategy.  This argument ignores the possibility that maximum long term returns may not be one’s primary objective.

As a retiree with increasing dependence on steady inflation linked income from investments my objective is sufficient short, medium and long term returns at minimum risk. Doing this requires careful attention to asset allocation. It is unlikely that index fund will provide the best solution since their composition is strongly influenced by investors with different objectives, in particular those seeking large long term (or even short term) returns  by investing in a restricted range of speculative opportunities.

With careful choice of individual active funds it is possible to achieve an overall allocation pattern that is compatible with one’s objectives.  Doing this with index funds is difficult because the only way to adjust an over allocation downwards is to buy more individual funds that invest in everything else which becomes impractical if one wants to cover multiple factors (country, size, sector, value vs growth, income).  This is easier with active funds because they provide a much wider range of different factor allocations.

So far all discussions seems to be based on 100% equity investing. ISTM that a fixed broad allocation  of bonds as provided by passive bond funds is totally inappropriate for meeting the objectives for which people generally buy bonds as recent events have shown. Better to buy individual bonds or active funds that make extensive use of bonds to achieve their objective.

People may be thinking about 100% equities, and the main way to reduce risk is to reduce the percentage of equities, but arguably the equities component of a <100% equities portfolio can just be invested in the same way as a 100%-equities portfolio. I don't think that's obviously wrong. Diversification within equities is vital in both cases.

What does diversification within equities mean? Some would argue that a global equities tracker is as diversified as you can get. Personally, I do interpret diversification in a more complicated way, including regional spread, big vs small cap shares, etc - probably somewhat similarly to you. However, I see little reason not to use cheap regional trackers to get my exposure to big cap shares. In small cap, I do end up using some active vehicles, partly because of what is available, partly because passive small-cap vehicles tend to be more expensive (than passive big cap) anyway. But I do try to keep average costs across my portfolio very low, because the costs are a known, and the best way to be diversified is a much more doubtful matter. Some portfolios are clearly not well enough diversified; others look reasonably diversified, but which is best? If in doubt, I'd favour the cheaper one.

I don't know what you have against passive bond funds. You can pick a suitable duration for your portfolio's aims, and government or corporate bonds or both, and sterling-only or global bonds, all while using passive funds. Do you need any more control than that? Again, if in doubt, I prefer to minimize costs, because costs are known, and that usually points towards passive funds. (I do actually hold both passive and active funds for corporate bonds, partly because the difference in costs happens to be small for the specific funds.)

My main argument against any sort of bond fund is that when you sell the majority of the underlying holdings will be far from maturity which adds greatly to the risk. You only get the full benefits of bonds if you hold for the full duration. I think that in the US you can get targeted date bond funds but I know of none available in the UK.

Bond index funds have the problem of being regarded as an easy safe way to manage diversification with non-equity. But they achieve this by deliberately avoiding any management beyond matching a % allocation.

Where a good active fund can help is that the risk can be managed. The partially mathematically predictable behaviour of bonds makes this easier than with equities. For example (IIRC) Capital Gearing Trust moved strongly into US short dated inflation linked bonds last year when concern about UK gilt prices was rising. They did not need spooky insight to the future to know that this was a safer option. I don’t have the skills, nor easy access to the investments, to do that sort of thing and am very happy to pay a manager to do it for me.

JohnWinder

…It is unlikely that index fund will provide the best solution…

You’ve floated this idea before but I’m still unconvinced that index funds aren’t likely a better choice.

Firstly, I think you’re talking about a ‘bucket’ strategy: assets for short term return; assets for medium term return; and assets for longer term return, each required to produce only-just positive real returns but a steady income long term. I think that summarises your

…dependence on steady inflation linked income from investments my objective is sufficient short, medium and long term returns at minimum risk.

Secondly, 

This argument ignores the possibility that maximum long term returns may not be one’s primary objective.

 For anyone who’s objective include the long term (despite not being a primary objective) then index tracking stock funds are a good choice for part of the portfolio, likely the cheapest with the best return on average for the risk level. So I don’t think the argument for index funds ignores your particular needs.

Your view seems to assume that the highest return might well be from an equity index fund, but that many people don’t need that much return or that much risk;  I do agree. But there are much higher returns to be had, if you leverage your stock investments by borrowing (this will increase your risk too); and there are lower returns, than un-leveraged stocks, to be sought if that’s all you need (and expose you to lower risk) with a stock/bond fund. But for any particular level of risk, everyone would want the highest returns available at that risk level. If we don’t make a sensible investment to get the highest returns we can at a particular risk level, then we have to go up a risk level to get the same returns. Not necessary.

A passive stock fund, a passive bond fund (the right one!), and a cash account can meet your stated objectives perfectly. And they should be able to do it at less risk and less cost than active funds, if index funds do really give ‘the same returns’ as active funds (as a whole) with less risk, and if they cost less. I think both are well established. It then just requires a bit of mental gymnastics to see how you get short, medium and long term income from those assets; rather than having active funds which deliver over the short term, the medium term and the long term.

Thirdly, you say individual bonds can do it for you but bond funds can’t. I agree about the individual bonds, but you can get a reasonable approximation with 2 or 3 bonds funds of different durations which are held in changing proportions to meet your spending needs. Practically speaking, it’s a bit too complicated for most people to take on I suspect, and UK seems not to have suitable funds for this approach, but it still uses passive funds to achieve what you’ve said you need, at low risk, and not all forum participants are in UK.

Linton

Another argument against bond index fund is that they are cap weighted. By far the majority of gilts are held by insurance, pension and other financial institutions who would, I believe, normally buy when issued and hold to maturity.  Their objective would be to have a known amount of money available at a known date to meet their liabilities.

This is very different to the use of bonds by small private investors.  It is difficult to see why the % allocation for one purpose would be appropriate for the other and good reasons to think it may not.  In particular a high allocation to long dated bonds.