Worth considering a modern take on the active versus passive approach to stocks and shares along with the benefits of genuine diversification when it comes to geographical sectors.
It is a long-standing unresolvable agony aunt of mine.
To remind you the difference between active and passive, active management is where you select a fund run by a particular manager and his portfolio construction, and hope that either he is very skilled or very lucky … or maybe both. Passive management mostly takes in index-tracker funds which track the performance of a particular index, for example the FTSE 100 or the S&P 500.
Active managers believe that through expertise, timing and pinpointing opportunities in the market, they can achieve higher returns. Their experience and forensic share analysis will tell them when to get into or out of a particular stock or bond. Successful active investment management requires being right more often than wrong.
Passive managers do not believe you can beat the market and it is far better to accept average returns.
Indeed, as Trustnet has highlighted, in recent times Investors have done incredibly well by simply holding cheap passive trackers.
Despite bouts of volatility, the outcome has generally been favourable for asset prices. Both equity and bond markets have delivered strong returns for investors, into double figures and well above the long-term average for global equities.
David Aujla, a multi-asset strategies fund manager at Invesco, commented: “Investors could essentially ‘set and forget’ their asset allocation over this period and experience strong returns at low cost. But the next decade and a half appear far less certain.
“Firstly, the high valuations of global equities today are likely to be a headwind to future returns. In other words, the annualised return experienced by global equity investors over the past 15 years is unlikely to be repeated.
“Second, markets have in some cases become more concentrated and skewed. US equities are a glaring example of this and they are a big part of the reason that the overall market looks expensive. In early 2012, US equities made up around 43% of MSCI ACWI and around 50% of MSCI World, the former being the ‘all countries’ index and the latter being ‘developed countries’ only. Today, US equities account for around 63% and 71% respectively. Currently, the equity market’s 12 month forward price-to-earnings ratio is around 30% above its longer-term average. While it may seem that the US has always outperformed, it’s worth remembering that this isn’t always the case. For example, in the first decade of the 2000s, US equities significantly underperformed the rest of the world, particularly emerging markets.”
He goes on: “I think a more flexible approach is a must. Having two-thirds of the equity exposure of a ‘global’ portfolio in one single country is a significant risk. The ability to adjust asset allocation over time will therefore be an important tool in the investor’s toolkit in the coming years. In short, take a more active approach, even if that is done by using passive underlying investments.”
And he adds: “For those who would rather somebody else make those active asset allocation decisions on their behalf, the good news is that the cost of active management has reduced dramatically. It is possible to access active asset allocation for relatively low cost. Over the next few years, I think that will prove to be a price worth paying.”
As for me, having been an advocate of mainly active investment management, I am now hedging my bets. I think a combination of active and passive styles in a portfolio seems a sensible way forward.