Investment is a crucial aspect of wealth management and there are different opportunities to be explored. The common feature of every investment no matter what you choose is that the value of your investment may fall or rise. In some situations, you may not even get back the value of your investment.
The major challenge faced by most investors is making a decision on which of the most popular funds they should choose – Active or Passive Investment.
A lot of people try to unravel the major differences that exist between active and passive investment. Although there are differences, the crux of both is to understand that each has its own uniqueness and one may suit your investment credentials better than the other.
To understand which investment you should choose, it is important to first come to the full grasp of what an investment fund is.
Investment Funds: What You Need To Know
Placing your money in an investment fund leaves you with having to choose from 2 main strategies, both being either active or passive management.
Although either of both depends on the investor’s choice, there’s been a long standing debate as to which strategy is the most effective.
When it comes to unit trusts and OEICs, your choice of actively managed funds undoubtedly supersedes passive funds.
There are currently over 2000 actively managed funds but the passive funds are still fewer than 100 according to the investment organization.
The access of investors to passive investments has however witnessed a major increase in recent times, thanks to the increased popularity of ETFs (exchange traded funds) as a new option for investors to explore.
The key talking points for a better understanding of active and passive investment includes
- Active management simply involves the manager putting in active efforts in an attempts to outdo some specified benchmark, usually a market index.
- Passive management includes every attempt by a fund manager to imitate some benchmark, reproducing its holdings and hopefully performance also.
- In the case of actively managed funds, they tend to attract high fees. Recent research has also questioned the ability of actively managed funds to outperform the market with any consistency whatsoever.
Active Managements – all you need to know
Actively managed investment funds are usually run by expert fund managers or investment research teams who take all the major decisions on your behalf. An example of this decisions includes when to buy or sell different assets.
An actively managed investment fund also has a personal portfolio manager, collection of managers, or co-managers who consistently make investment decisions for the funds.
The chances of success for an actively managed fund largely depends on the combination of various variables like market forecast, in-depth research aswell as the experience cum expertise of the manager or the management team.
The purpose of the management team is usually to deliver a return that outweighs the market entirely or for funds with more conservative investment strategies. All these are aimed at protecting capital and the prevention of a greater loss in value in case the market drops.
The role of managers in active managed funds
Actively managed funds keenly depends on the fund manager or team making the right calls. This guarantees a potentially higher returns than a market provides.
Otherwise called portfolio managers, the fund managers are engaged in a continuous supervision and monitoring of marketing trends, shifts in trading pattern, changes in economy aswell as political terrain and also factors that may affect the performance of specific companies.
The data obtained during the monitoring of the market is deployed in order to ensure more accuracy in the buying or selling of investments. This leads to the mastery of market irregularities.
Active managers say that these strategies of management yield better returns when compared to those achieved by replicating the stocks or other securities listed on a particular index.
The core advantage of the active management is that when there is a portfolio manager who’s in charge, they can tactically evaluate particular sectors that have the potential of booming. Also, when a particular region starts to diminish, the fund manager can swiftly move your money to help you take advantage of the growth or protect you from the looming losses.
Since the top responsibility of a portfolio manager in an actively managed funds is to stay on top of the market, it is also expected of them to get involved in more risky adventures in order to enjoy more returns. Indexing helps in eliminating this as there are no chances of human error as far as stock selection is concerned.
Passive Fund Management – all you need to know
Also referred to as index fund management, passive management is all about the creation of a portfolio intended to track returns of a specific market index or benchmark as closely as possible. The managers then select stocks aswell as other securities listed on an index and apply the same weighting.
The idea of the passive fund management is to produce a return that is similar to the selected index rather than outdoing it.
Passive investment funds usually track a market and in turn charge lesser when compared. The funds are strategically run by a computer and will purchase all the assets in a particular markets or the majority in order to reflect in your returns, the market performance.
Unlike what is obtainable with active fund management, a passive management doesn’t have a manager or management team making investment decisions.
Passive fund management can also be structured as an exchange traded fund (ETF), a unit investment trust or a mutual fund.
Index funds are usually tagged as passively managed because each has a portfolio manager that mimics the index instead of trading the securities based on his or her knowledge of the risk aswell as the reward properties of each risk.
The major talking point as regards passively managed funds is that the investment strategy isn’t proactive and this means that the management fees assessed on the passive funds are always lower when stacked against active management strategies.
Actively vs passively managed funds – how do they measure against each other?
There is a semi-annual report that weighs the performance of both active and passive management funds – The Morningstar Barometer.
The barometer is unique in the manner in which it measures the success of active managers in relation to passive funds. Actively managed funds are measured relatively to their investable passive alternatives within the same category.
In 2018, there were 4 major takeaways as far as actively and passively managed funds of the year is concerned
Morningstar revealed that
- Only 38% of active US stock funds survived and outweighed their average passive counterpart in 2018, with the figure dropping from the previous year – 46% in 2017.
- Actively managed funds’ rate of success fell as compared to 2017 in 16 of 20 examined categories. It was revealed that about 35% of active funds outperformed the passive peer for their category in 2018.
- From a general point of view, active funds haven’t recorded much success nor outweighed their benchmarks especially over longer time horizons. It was discovered that only 24% of all active funds outperformed their passive rival in the space of 10 years that ends December 2018.
- The data conclusively suggests that the average active dollar has outdone the average active fund. The implication of this is that investors now opt for high quality and cheaper funds.
Actively or passively managed investment? – based on your choice
Generally, your choice usually depends on your investment personality. Both the active and the passive funds have their unique benefits.
Whether you are investing on your own or working with a financial adviser doesn’t matter, you can settle for either of the two or choose both. As a matter of fact, many advisers usually blend active and passive strategies for a better performance.
Opting for either actively or passively managed funds is to a large extent dependent on your investment objectives as well as what matters to you as an investor.
Before you settle for your desired investment style, it is in order to ask yourself the following questions.
- How much risk can you take?
Higher risk investments comes with a greater possibility of losing more money. On the other hand, they also have huge potentials in terms of yielding greater returns on your money
- How much returns do you expect to make on your investments?
Highlighting how much returns you need to make on your investments helps you reach your financial goals faster. Always remember that to get a higher return you also need to take a higher risk.
- How long do you plan to trade?
It is important to set your investment time horizon and identify the required amount of time needed to meet your goals. Your time horizon could be either short term or long term. In addition, knowing when to enter and exit the market is also crucial
- How soon do you need access to your money?
Liquidity summarizes how easy it is to obtain your money back from an investment. Bank and cash investments have a higher liquidity but returns are low. Investments with lesser liquidity often offer a higher returns alongside an increased level of risk.