Active or passive investment strategies

In recent years substantial sums of investor capital have been invested in passive investment strategies and moved out of more traditional active strategies.

Passive investing, otherwise known as index investing, is a style of investing that mirrors an underlying market. For example, a particular investment could be purchased to replicate the performance of the Australian S&P/ASX 200 index. In theory, its performance should match that of the index, no more or no less.

Active investing involves an investor or asset manager attempting to use their skill to outperform the market.

One of the main attractions of index investing is its low-cost nature. And the fact is, in recent years, many active fund managers have failed to outperform the benchmark, leaving investors to ponder, why bother paying additional fees for active management?

One of the main concerns with many passive index investments is that the strategy is based on market capitalisation (size) and price movement, not by changes in the value and quality of the underlying business. 

For example, if you buy an index fund that replicates the Australian S&P/ASX 200 index you are effectively buying a piece of the top 200 companies on the Australian share market. The higher the share price rises of a company within this index, the more of that company you are “forced” to buy. You are essentially buying yesterday’s winners and hoping they become champions of tomorrow.

Conversely, if a stock falls in value the index fund would reduce this position to maintain its level within the index’ weighting. Or sell it altogether if it drops out of the index.

But investing isn’t always that simple. Markets move in cycles, up and down. Quite often yesterday’s winner is a company that you may want to reduce or sell, not add more to. And a quality business that falls in price may present an opportunity to top up. Index investing does not allow for this. It goes against the adage of buy low, sell high.

I am not saying that index investing doesn’t have a place for investors. If low cost investing is your number one objective and you have a long-term investment view, with a sound asset allocation approach, there is no reason why this investment approach could not work.

But if you choose a qualified and proven financial advisor, an active investment is always worth considering. You need to find the right financial advisor/asset manager to work with.

 Client outcomes should be the main priority. Investment decisions should be driven by client needs and tailored to individual circumstances and financial outcomes. There is no point investing in the cheapest fund if it is not meeting your goals and objectives.