Passive – Active: it’s not either/or

At a glance:

• The debate between active investing (where a fund manager picks stocks to try and outperform the market) and passive investing (where the aim is to replicate the market) is now dated.
• Today, there are a range of options between these two poles.
• We look to combine different options to give you the benefits of each and provide you with a well-diversified solution.

The basic argument for active management is that skilled managers can identify winners and avoid losers in the stock market, delivering a better return than the market itself. Meanwhile, proponents of passive management argue that simply following the market removes the risk of human error andis cheaper.

That argument is over, says Dr Sarah Ruggins, SJP’s head of investment specialists. There is a world of investment techniques that exist in between these two poles. “We’re unnecessarily constraining our opportunities if we limit ourselves to all active or all passive,” she says.

Instead, we look to use both active and passive management – and everything in between. Sarah points out there is a spectrum between the most basic passive, low-cost strategy, through hybrid options up to the most active of managers, who invest with no regard to indices.

A false debate

While the first decade of the millennium saw active funds generally outperform, the past few years have favoured passive investing, she says, thanks to the performance of just a few companies dominating market returns.

Investor sentiment is much like the market – it’s cyclical. When something is popular, money finds its way there. Which is why, Dr. Ruggins comments, it’s unsurprising passives has done so well of late, given the popularity and rise of the largest tech stocks in the world – colloquially known as the Magnificent Seven (i.e. Amazon, Apple, Microsoft and so on).

She adds: “Investing is for the long term, and success doesn’t come down to last-minute changes. Being disciplined and diversified are key to sustainable performance over the medium to long term across all market conditions. If we fall into the either/or game around active and passive, you won’t be truly diversified.”

Understanding passive

The primary goal of passive strategies is to match returns from an index or benchmark with as little tracking error – or deviation – as possible. However, which index a passive fund tracks also matters, Sarah notes.

For example, a fund that tracks a ‘cap-weighted’ index like the S&P 500 will have a high allocation to the big companies like Apple. It’s a straightforward way to invest passively.

But there are alternative approaches that funds can take. They could track an equally weighted index, having the same allocation to each company regardless of its size. So, in an equally weighted S&P 500 fund, Apple and Domino’s would have identical allocations, despite Apple being a much larger company.

Sarah concludes: “Passives aim to reflect the market, but how you define that market matters. When it comes to passive investing, we need to remember an index is still a filtered way of looking at the entire market opportunity set.”

Active funds

Similarly, there are different types of active fund management, and it would be a mistake to view them all the same way.

Typically, an active fund would see a team researching and picking investments. Their scope could be as broad or narrow as required, for example aiming to only invest in a certain number of companies, or only within a certain market, or index.

Systematic funds are another example. They use proprietary information to make trading decisions. As they aim to beat the market, they can be considered active. On the other hand, systematic funds follow set rules, which they can’t deviate from on an opportunistic basis, Sarah notes.

We can use systematic funds in portfolio planning alongside other actively managed funds to add liquidity and flexibility or to reduce costs, she explains. This is why investors need to be aware there is more than one type of actively managed fund – even though we often refer to them as a homogenous style of investing.

Sarah concludes: “All active management styles are not the same but what unites them all is the aim of beating the market return by making informed decisions instead of just following rules.”

By looking to blend different types of passive and active funds, including systematic ones, we can create truly diversified investment portfolios and solutions for you.

The value of an investment with St. James’s Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than the amount invested.

Past performance is not indicative of future performance.

SJP Approved 23/01/2025