What is “Active” and “Passive” Investing?

What is “Active” and “Passive” Investing?

When it comes to active and passive investing, professional wealth management advice gives many options and routes available to the investor.

Some investors prefer an “Active” approach to investing, whereby the manager looks to out-perform or beat the market. Others investors take the stance that over the medium to long term an Active approach delivers no real additional value over market return, and these investors prefer a lower cost “Passive” approach to investing by way of Tracker Funds, that is funds aiming to replicate the market or benchmark and not beat it.

Active Investing

Active investing requires solid research facilities incorporating deep market analysis. It is a very hands-on approach to investment management. Holdings that are perceived undervalued or those with good future growth prospects are sought out.

Market fluctuations, of which there are currently many, provide good buying and selling opportunities for the active investment manager (buy low – sell high).

Passive Investing

Passive investing attempts to replicate the return of an index or benchmark (for example the FTSE100). The approach is not to attempt to beat or to time the market, yet simply replicate the market return – the costs of this approach is typically far lower than that of active investing.

Active – Pros & Cons

The main benefit of Active investing is the greater flexibility afforded to the fund manager when trading, being able to move money to potentially profitable opportunities and away from those that are less so.

As a result the active manager will attempt to produce a higher return than the market itself. The main disadvantage is that the manager may not get this right every time. There is also the additional cost of this layer of active management plus the underlying trading and fund costs.

The higher charges will be a drain on performance, and it is a case of whether any additional return will exceed charges, therefore producing a higher return for the investor.

Passive – Pros & Cons

The perceived benefit of a Passive approach to investing is that the market is “efficient” and cannot be beaten on a regular basis. It is hoped that this lower cost approach over time will demonstrate this with superior returns to active management.

One counter intuitive factor for some is that in a downward market movement the fund deliberately tracks the market down. If it replicates the market up or down it is doing its job.

Not all passive funds are as successful as they would like to be and are judged by their “tracking error”, that is over or under performance of the benchmark that it is tracking. Charges, although typically low, also affect the tracking error of a passive fund.

So which strategy should I choose?

Deciding on whether or not you are an active or passive investor will be a discussion to have with your wealth management specialist. They will look at a number of factors including current market conditions, your investment objectives, how much you have to invest, your time frame for the investment as well as your attitude to investment risk and your capacity for loss.

There is no right or wrong answer here, and only hindsight will tell us over any specified investment period which was the best approach. Blended funds offering a combination of both approaches and are gaining ground and are becoming more popular.

Such a mid-priced hybrid fund of the two approaches may provide the best of both worlds as perceived by some, or in fact the worst of both worlds as perceived by others. Investing is after all a very personal experience.

Specialist wealth management advice

If you have a question about your current investments or are looking to invest now, then please get in touch with our wealth management specialists here at Pensionlite, we are always happy to help you navigate your investment journey.