Time to move beyond the active versus passive debate

Renato Mota, Group General Manager - Wealth Management

Renato Mota

Just the mention of active versus passive investing can spark intense debate over their relative merits. One approach, however, doesn’t have to be at the expense of the other. In different markets and at different times, either strategy, or a combination, have produced favourable results for clients. Not being wedded to just one point of view (especially one that is based solely on investment returns) offers the flexibility you need to find the right solution for what your clients really value – the peace of mind knowing they are on track to achieve their retirement goals.

From risk management to investment returns, there are also shades of grey in the active versus passive debate which reinforce the importance of considering the bigger picture of your client’s goals and objectives beyond investment fundamentals.

Active vs passive - shades of grey

Pure passive investing is based on the idea that all the information that it is possible to know about a market or stock, is known. When the ‘information edge’ disappears, as is likely for large cap stocks which have thousands of analysts poring over their financial results, the efficiency of markets makes it harder to outperform.

For the small-cap universe, where less is known or expert knowledge can come in to play, there are greater opportunities for active managers – and it’s an area where active managers have been able to generate returns above the benchmark. To 31 December 2015, over the previous three years the median active Australian small companies’ manager generated a return of 13.5 per cent pa1 versus a passive return of 9.0 per cent pa2.

Active fund management doesn’t necessarily mean fund managers take on more risk. Having access to risk-mitigation tools, such as hedging or simply the ability to sell when the risk gets too large, provides reassurance to your clients who worry about major market falls.

Active investing has shown better-than-market returns in times of higher volatility and market downturns, such as 2001/02 and 2008/09. In these times, when correlations between stocks are falling, active managers are in a stronger position to exploit outliers. Alternatively, passive investing tends to perform better when market correlation is high.

What should be the real conversation?

The traditional active versus passive debate should move beyond the traditional mindset of the value of financial advice being attached to investment returns. Clients, as I have written previously, overwhelmingly say achieving their lifestyle goals, and not investment returns, is the definition of a successful financial planning experience.

An advice strategy which focuses on helping clients set specific goals (and for subsequent meetings tracking progress against those goals), makes it easier for you to show – and your clients to understand – the value you bring and keeps your clients engaged and looking beyond the ups and downs of the financial markets.

1  Median return in the Mercer Aus Small Companies (ex 100)
2  Mercer, based on S&P/ASX 300 Accumulation index

The information contained in this newsletter is provided on behalf of the IOOF group of companies and is intended for financial adviser use only. It is given in good faith and has been prepared based on information that is believed to be accurate and reliable at the time of publication. Any examples are for illustration purposes only and are based on the continuance of present laws and our interpretation of them at the time.