Active vs passive investing

ARTICLE WRITTEN BY DUANE NICHOLLS CFP®

Hybrid investments fall into a unique space as it assists us advisors with deciphering the right means of investments for our clients. It is essential that that advisors understand the key differences between Active and Passive Investments and how it affects your client.

Thandi Ngwane, a Senior Member of the Distribution Team at Allan Gray, insightfully notes that each advisor must begin their approach to investments by determining whether the Asset Manager is ‘active’ or ‘passive’.

She says: “Active Managers study individual assets or groups of assets and make an active choice about which to own for their clients and which not to own – thus the word ‘active'. They think that the market sometimes misprices assets, such as shares, bonds and property, and that this creates opportunities to earn a return, for example to buy a share at a discount and then to sell it when it goes up in price.”

She also notes that Passive Managers “don't make any active choices about what to own and what to leave out of their clients' portfolios, they just buy a small amount of all the shares in the relevant stock-market index, normally in proportion to the market price of the company that that share represents. Since they don't try to make active choices, their philosophy implies that the price of shares is efficiently set by the share market, in other words, that the current price of each share is the best indicator of its long-term value.”

Active Managers excel at managing the clients expectations as they have lower volatility methods in comparison to Passive Managers. However, this expectation comes at a monetary cost as Active Managers actively manage the market through the buying, selling and discovery processes. In the long term, a Passive Manager may be more suitable for your client’s needs as the cost is lower over that period enabling the client to experience more returns.

As much as Active Managers do seek to outperform the markets, we find that only 15% to 25% of these managers are able to do so on a consistent basis. The debate for Passive Management is therefore strengthened by this argument coupled with the lower portfolio fee structures.

So what is your investment philosophy?