MARKETS & INVESTING
PASSIVE & ACTIVE – THE CASE FOR BOTH
David Aujla Multi Asset Fund Manager Invesco
At Invesco , we spend a considerable amount of time thinking about portfolio construction . For some of our multi-asset portfolios , this means thinking about active and passive investment styles ; an old-age and perhaps controversial debate , as proponents on each side are equally convinced that their approach is superior . While tempting to make an ‘ all-or-nothing ’ active vs passive decision , we believe investors should explore the possibility of combining both approaches , thus allowing their portfolios to benefit from the advantages that each have to offer .
The view on passive Passive funds – arguably one of the most revolutionary innovations in investment history – have grown in popularity in recent years . Their numerous benefits have been widely documented . Amongst other things :
• they offer an affordable way to access markets
• the post-GFC ( global financial crisis ) period has been highly conducive for passive indices to outperform their active counterparts
• the range of available passive instruments has increased considerably ( e . g . geography , sector , duration ) giving investors a wider investment choice . Nevertheless , passive management is not a cure-all solution . Investors should take note of some of its limitations , including but not limited to :
• the inability to outperform ‘ the market ’ in rising and , particularly , in falling markets
• in volatile times , the tracking error of passive indices tends to increase , making their performance less predictable
• passive indices are often tainted with construction biases , such as a high concentration risk in a limited number of securities .
The view on active While passive managers seek to own all the securities in a given index , active managers select specific investments based on an assessment of their worth . Therefore , rather than ‘ owning the market ’, active management aims to ‘ beat the market ’. The principal criticism of active management is well known ; it is more expensive than passive investing , yet has often delivered less performance . So , when and why is active management likely to realise its full , market-beating potential ? Arguably , this should occur in periods of increased market turbulence when there is more dispersion between stock performance . We saw this happen , for example , in the wake of the dot-com bubble burst and , more recently , at the height of the COVID-19 pandemic and after last year ’ s market correction . Relatedly , a further appeal of active management is that , unlike passive investing , it recognises the innate inefficiency and irrationality of markets and their participants . Such insights could be particularly useful when exploring opportunities in more specialised areas such as small and mid-cap equities , emerging markets and corporate bonds .
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