Active support for your money!
The universe of investment funds is very large and varied. But when it comes to the way in which they invest, most funds fall into one of two categories – active or passive.
Active funds more obviously fit the image of stock market investing being about someone buying and selling investments in order to make a profit. These are funds in which the manager has the freedom and flexibility, within parameters set by the objectives of the fund, to make investment decisions in order to boost performance and/or minimise volatility.
Two sides of the same coin
Their ability to pick sectors or companies that they expect to do well gives active fund managers the opportunity to seek enhanced returns. They can also time their investments to attempt to benefit from market movements, industry trends and macro developments.
But while fund managers have access to vast resources of information and research, active investing relies heavily on the quality of those resources and the skill of the manager(s). And it can be a challenge for even the most skilled managers to deliver sustained, consistent results. For example, just 11% of active US equity funds investing in large companies managed to beat the US stock market over the past decade, Bank of America research found.
Recent years have seen passive funds, such as ‘trackers’ and Exchange Traded Funds (ETFs), rise in popularity. These funds are set up to follow or replicate the performance of a certain index or basket of stocks. Passive funds typically have lower charges, perhaps the biggest factor in their rising popularity at a time when investors are increasingly cost conscious.
Unlike active funds, however, passive funds simply track their index or basket of stocks up and down. By definition they have no ability to outperform or protect investors from price falls.
Getting the best from both
As more investors have turned to passive funds in recent years – particularly ETFs debate over the merits of the two strategies has intensified. Each side has its passionate advocates, but some see the debate – which tends to focus on which is best – as an unhelpful one because it is possible for investors to use a mix of both to achieve their goals.
One way is to follow a ‘core’ and ‘satellite’ strategy were most of your portfolio is invested in a diversified range of low-cost passive funds that will provide returns in line with the broader market for each asset class. These are then supplemented by active funds, with a view to boosting performance and offering some element of downside protection.
Alternatively, you might have a portion of your portfolio that’s going to be left untouched for a long period, allowing it to ride out volatility over time. That could be made up mainly of cheaper passive funds. Active funds could then be used where you have a more medium-term focus and so may be more concerned with smoothing market ups and downs.
When volatility strikes
Investments go down as well as up and there is always a risk you can get back less than you put in, but in times of downturn and high market volatility – like those we have been experiencing recently – there can be some comfort in taking the ride with an active manager. At least for some of your money.
That’s because active fund managers have the flexibility to make investment decisions with the aim of minimising risks. They can also take advantage of any opportunities that those conditions create, such as companies or sectors likely to bounce back more quickly.
Some funds will do that better than others, of course. It depends largely on the risk profile – a fund invested mostly in cash and fixed income might minimise losses, but it won’t benefit much from the eventual recovery. However a fund invested mostly in equities might suffer more in the downturn before bouncing back and profiting from the market recovery that’s likely to follow.
Making it personal
The way in which investments are spread across – and within – active or passive funds in a diversified portfolio will ultimately come down to factors such as your objectives and risk profile. And when you’re using active funds, it will also be dictated by their performance.
Whether a fund is going up or down in price isn’t as important as you might expect. What matters most is how well or poorly it is doing by comparison with similar types of funds and in the context of market conditions.
If a fund has fallen 10% in the past six months we might think it’s doing badly. But what if its objective is to beat the FTSE 100 index and that index is down 20% over that period? It then begins to look different, which is why relative performance is what really matters.
This is the basis on which your financial adviser will assess the funds in your portfolio, whether they are actively managed or passive (where ‘tracking error’ can sometimes occur). They will set up and maintain that portfolio on the basis of the agreed risk-reward strategy, meaning that your investments are designed to match your risk appetite while still meeting your objectives.
As the implications of the coronavirus outbreak continue to unfold, it’s possible some of us will need to review our plans. But the key is to hold firm and remember that investing is for the long-term. We will have built your portfolio on that basis, with your personal financial goals in mind.
Do you have questions?
We’re here to help. Please contact us if you have questions about your current portfolio or would like to talk about a portfolio review.
This article is provided by Murdoch Asset Management Ltd for general information only and takes no account of personal circumstances. It is not a recommendation to buy or sell. Please be aware that the value of investments can fall as well as rise, so you could get back less than you invest.
Murdoch Asset Management Limited is authorised and regulated by the Financial Conduct Authority.
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