Passive versus Active Investing – by Luke Styles

For those not working within the Fund Management business, you are forgiven for being unfamiliar with the title of the article.

What is this versus that all about anyway?

For investors out there, which includes most working and retired Australians, it can mean a difference of thousands of dollars by choosing the investment style of the underlying management for your investments.

The detail.

Active Management is where a fund manager, investment manager, or even a financial adviser to a lesser extent, invest funds to outperform the benchmark it tracks. Think of it as actively trying to pick the next ‘winning’ stock and dumping the ‘losers’. The tracked benchmark is often a parcel of Shares or investments, commonly referred to as the ‘index’. This index may consist of the top 200 shares on the Australian Share Market or the top 500 on the US Share market, often referred to as the ASX 200 and S&P 500, with the Active Manager attempting to outperform these indices.  Active funds are benchmarked against many varying indexes depending on which markets the fund invests in.

An issue surrounds Active Funds Management systemic underperformance. In fact, over 80% of Active Managers  under-perform over the medium and long-term when compared to the indices they track, often underperforming by the management fee charged. It is worth noting that the un-managed ‘index’ fund by its very nature has low fees, as the fund takes no interest in the next ‘hot stock’ but rather a benign buy and hold approach.

So now we know that the majority of Active Funds underperform the indices they track. Why don’t we all own index funds then? Great question! My suspicions lie with the highly profitable industry that is Active Funds Management, convincing investors that they can uncover the next hot stock or investment.

Now, what makes index funds so good at what they do. Well, I’ve already covered a couple of the key points, being the low cost, often a fraction of their Active Manager counterpart. However, beyond this lies the inherent buy and hold nature of the fund, providing tax efficiencies for the investor. Furthermore, the Index fund is ‘dumb’ to the next hot stock, meaning the fund by default often holds upward of 200 stocks, and if the next Apple, Amazon, or Google sits within this parcel of Shares, it is often owned far earlier than the Active Fund Manager counterpart.  This can lead to additional investment value for the index investor.

There are a number of other advantages to being an Index Investor not coved within the blog so if you want to know more about index fund investments please get in touch with the team at Steve May Financial Services.