Investing funds actively vs passively: the great debate

When it comes to investing, there are two dominant approaches to investing funds: active investing and passive investing.

Both investment types have their own merits and drawbacks - which is why they’re often the subject of heated debate. Our view is that neither one is better than the other. It’s all about the right fit for a client’s objectives and their approach to risk, so understanding the nuances of the two approaches to investment management is vital. In a nutshell, the choice is ‘the market return’ OR a range of returns, some of which might be ahead of the market, though some might be behind.

Let's start with active investment management

In the simplest terms, an active investment strategy tries to beat the market, aiming for returns higher than the market index. The fund manager aims to outdo the market’s return through actively selecting individual holdings within the fund.

In that sense, actively managed funds can give you more freedom. Carefully picking and choosing what you want to invest in can help build up a diversified investment portfolio. And diversity is key, because it helps spread risk around.

Active investing also allows an element of participation you won’t get with passive investing. Many people want to choose how their money is managed – especially those with strong sustainability preferences or other personal strategies, say drawdown.   

However, the level of management input involved means that actively managed portfolios can be expensive. This is applied brainpower - you’re paying a fund manager for their research, their expertise and oversight of your portfolio as they search for the most potential for returns.

There are many studies that suggest most active funds end up trailing behind the market average, so finding golden opportunities that deliver beyond market returns is no mean feat. Experience suggests though that there will be times when active management is well worth paying for.

It’s also worth remembering that active investing is the only way to access certain opportunities – illiquid or unquoted equity markets, for example.

So what about passive investing?

Passive investing is a more hands-off approach to portfolio management. Instead of trying to beat the market, you’re just trying to match it.

This makes passively managed funds more straightforward – rather than aiming to outperform the market, passive investors just go with the flow. They invest in things like index funds or Exchange Traded Funds (ETFs) that simply track the index. It's like putting your money on autopilot and letting it fly.

And this means it’s usually cheaper, because you're not paying active fund managers to do all the work, and track market benchmarks.

Are there other investment options?

ESG (environmental, social and governance) investing is growing in popularity as investors are becoming increasingly concerned about our changing climate.

Investors are now increasingly looking to invest in companies that don’t only think about the bottom line, but offer solutions to environmental and social issues. They’re looking to invest in assets that make a positive difference. And we support this.

Although ESG investing isn’t a middle ground between active and passive investing, ESG funds can be invested actively or passively. But for investors with strong sustainability preferences, active investing is necessary.

At Parmenion, we launched our Ethical solutions in 2012 and have been leading the way ever since, with our range of ethical investment styles including active and passive options.

So what's the answer when it comes to active vs passive?

Our conclusion is that there’s a time and a place for both approaches, which is why Parmenion Investment Management offer both.  

Passive is great for fire and forget, long term investing where a generic solution will do just fine and you’re happy with asset classes where there's not much room for active selection.

For personalised strategies and much wider access to markets, active has to be a consideration.

The Active vs Passive debate isn’t going away any time soon.

This article is for financial professionals only. Any information contained within is of a general nature and should not be construed as a form of personal recommendation or financial advice. Nor is the information to be considered an offer or solicitation to deal in any financial instrument or to engage in any investment service or activity.

Parmenion accepts no duty of care or liability for loss arising from any person acting, or refraining from acting, as a result of any information contained within this article. All investment carries risk. The value of investments, and the income from them, can go down as well as up and investors may get back less than they put in. Past performance is not a reliable indicator of future returns.