22 April 2019

The Myths of Passive Investing

I believe in passive investing ... almost as much as I believe in active investing! If you are not familiar with the terminology let me briefly explain...

In broad terms "passive" investments refer to investment funds whose value follows an index (the FTSE 100 being a well-known example), whereas "active" investments have a fund manager making informed decisions on how to invest the fund's money. One key point is that passive funds have a lower annual cost, simply because there is no fund manager with a research team to pay for.

What I do as an adviser is to aim for the best investment performance within the constraints a client has given me. Among other things that requires balancing the extra cost of active investing, versus the extra performance which you hope for.

The problems start when people who should know better tell you that active funds do not, on average, perform any better than the cheaper passive funds. That sort of brain dead reasoning is absolutely true but absolutely meaningless! The whole point is that passive funds in general give you "average" performance - that is what an index is! And therefore there will always be active funds which do better and those which do worse.

But if, with a little work and expertise, you can find an active fund which has a reasonable expectation of doing better than the equivalent passive fund (by more than the additional cost), then you are en route to out-performing that passive fund.

The argument put forward by the passive camp often seems to assume that an adviser or investor will simply use a pin to select some random active fund which may or may not do better than the index. For example, one adviser claims: "Only 21% of global equity funds have outperformed their [index] over the past 15 years". That may well be true, but through research and experience and periodic monitoring I would expect to have selected one of those 21% funds.

If an adviser is only offering to give their clients average investment performance that's fine, so long as they make that clear to clients. But my aim is to do better than average for my clients!

Having said that, there are some investment markets where it is very difficult to reliably do better than an index - US equities is one example. In that case, a passive fund is the most effective approach.

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