Investment: Active or Passive?

Had I been writing an article on investment at the beginning of my career in 1971, I would only have been talking about “active” investing, because the concept of “passive” investing was only then beginning to emerge in the United States. In fact, it was only in 1973 that Burton Malkiel wrote, “A random walk down Wall Street” and a year later he founded the Vanguard Group to offer index investing.


So what is active investing?

Active investing is what most Stockbrokers have been undertaking since the emergence of shares in companies in the 15th & 16th centuries. An active manager uses skill, knowledge, expertise, research, etc to recommend particular shares that they reckon will perform better than the market. These theories extend to other investments – fixed interest, property, commodities, alternative investments, etc – to create actively managed portfolios.

So what is passive investing?

In its most simple form, passive investing is tracking a single market to obtain the return from that market. One of the first index-tracking funds was an S&P 500 fund, managed by Vanguard and launched, very modestly, in 1975, which, on 30 June 2017, had assets of $329.3 billion! See my extended blog on passive investing.

What are the differences?

The following chart summarises the key differences:

Characteristics / Potential for: Index Investing Active Investing
Above-market returns No Yes
Below-market returns Yes, a little (after fees) Yes
Protection in falling market No Yes
Fees (10bps = 0.10% per annum) 10-30bps 75-220bps
Complexity Low High
Different risk/return profile from index Low High

Why would I invest passively?

The above table shows that charges for passive investments are significantly less; in some cases just 5% of the charges for some of the most costly actively managed funds, which is a compelling reason in its own right.

However, the key argument from passive managers is that active managers are unable to consistently improve upon market returns. The following table is a little out-of-date, but it graphically illustrates the point I’m trying to make (Source: Vanguard):

01/01/00 – 31/12/04 01/01/05 – 31/12/09
Fund Name Rank Total Return
Rank Total Return
Rathbone Recovery 1 16.68 236 -46.91
GAM UK Diversified 2 14.09 135 27.53
Saracen Growth Beta 3 13.60 154 22.40
Fidelity Special Situations 4 13.35 28 49.51
Schroder UK Mid 250 5 10.35 128 28.13
Cavendish Opportunities 6 7.60 217 8.27
INVESCO Perpetual UK Growth 7 7.59 205 13.65
MFM Bowland 8 5.19 204 13.93
BlackRock UK Special Situations 9 5.84 36 46.61
Investec UK Special Situations 10 5.64 32 47.79
Artemis UK Growth 11 4.88 220 6.29
CF Walker Crips UK Growth 12 3.57 33 47.73
Rensburg Uk Mid Cap Growth 13 2.37 1 88.18
HSBC FTSE 250 Index Retail 14 1.99 38 44.86
BlackRock UK 15 1.84 91 32.86
IMA All Companies Index -1.98 31.44
FTSE All Share Index -2.96 36.82

Why would I invest actively?

Really, it is a question of personal preference and having faith in a particular Investment Manager. In recent years, we’ve seen vast sums of money follow Investment Managers such as Anthony Bolton (the highly successful manager of the Fidelity Special Situations Fund) and Neil Woodford (equally successful manager of the INVESCO Perpetual High Income Fund) when they set-up new investment arrangements.

Can I get the best of both worlds?

There are a number of modern funds that combine the key elements of active and passive investing, so that Investors can benefit from lower charges whilst still having the potential to outperform the market, both in terms of upside potential and downside protection.

The following table gives some examples of the types of combinations available:

Asset Allocation Securities Type of Fund
Active Active Traditional Active Multi Asset fund
Active Passive Funds with Active Asset Allocation, Passive implementation
Passive Passive Funds of trackers using a limited & auto-rebalanced asset allocation
None Passive Individual tracker funds

Asset allocation is the process of deciding where the money should be invested. At the highest level, this will be a question of which asset class – shares, fixed interest, property, commodities, alternatives, etc. At a secondary level this would include such things as geographical spread and, in the case of shares, whether they should be in small, medium or large companies.

Some passive funds employ some very sophisticate techniques to improve upon the pure market return. For example, Dimensional, another major investment house, bases its model on a wealth of academic research that shows that shares in smaller, value companies, with consistent profits have consistently outperformed shares in larger, growth companies with inconsistent profits. Consequently, their funds are skewed in that particular direction.

Do you have a preference?

Personally, I invest passively, but, when advising Clients, it is a question of understanding their particular requirements, expectations, degree of past familiarity with the world of investment and the extent that they are going to take an interest in the “nuts and bolts” of their portfolio in the future. In view of the lower charges and more predictable returns, my starting point will always tend to be passive or passive with an active overlay, rather than purely active.

The risk warning

Whether it is active or passive, the market value of investments and the income from them can go down as well as up. Shares may be subject to sudden and large falls in value and you may get back less than the amount invested.

Past performance is not a guide to the future.

What next?

If you have cash to invest or existing investments you want to review, complete the form below and I’ll create a link for you to or risk profiling tool, which will help us – you and I – to establish your attitude to risk. Beyond that, if you wish, I can analyse existing investments to see if they fit in with your stated attitude to risk.

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    About Clive Barwell

    Clive Barwell is one of the most experienced and qualified financial planners working in the later life market today, he specialises in advice and guidance for the over 55s. To ask Clive a question, please email him at Alternatively, you can follow Clive on Twitter, connect with Clive on LinkedIn or see Clive's profile on Google+.