Active vs passive investing

30/04/2019

Funds come in many shapes and sizes, and try to achieve different things using their different approaches. There is a fundamental distinction to make between two of the overarching approaches to managing a fund – active and passive investing.

It’s important to understand the differences between these investment philosophies which, to an extent, can be seen as polar opposites. In this article, we outline the key points of differentiation, as well as some of the pros and cons of each.

Glossary

For explanations of the investment terms used throughout this article.

View the glossary

1. Active...

Actively managed funds are run by professional experts who make investment decisions on your behalf.

Each active fund will have its own specific investment objective – beating the average returns of a stockmarket or paying a growing level of income to its investors, for example. This should tally with what you want or need from investing, not least your attitude towards risk.

In line with what the fund sets out to achieve, managers will invest in a range of individual assets – company shares or government bonds, for example – that collectively comprise the assets of the fund, which individuals can then access in one single investment.

Active fund managers believe that by using analysis, research and proven investment processes to make informed decisions, it is possible to outperform the market. Rather than following the herd, active managers aim to make better-than-average calls and, in turn, deliver better-than-average returns to those who invest in their fund.

Fund managers will charge for investing your money. If your investments are successful, the returns should have the potential to outweigh the costs of investing.

2. Passive...

In contrast to active funds, passively managed funds look to closely track the performance of a particular market benchmark or index.

The composition of a passive fund will therefore be closely aligned to the basket of assets that comprise that market index. For example, a passive fund of UK company shares might invest in the companies that comprise the FTSE 100 benchmark index in line with their relative weight in the index.

A passive fund, by design, should rise and fall in line with the market index that it tracks. While this reduces the risk that your investment will underperform relative to the overall market, it also means that it won’t be able to meaningfully outperform – unlike an actively managed fund. Exchange-traded funds (ETFs), which track a given market index but trade like a stock throughout the day, are a popular form of passive investing.

Passive fund charges tend to be lower, sometimes much lower, than for active funds, because there is less ‘added value’ by the provider, in the form of expertise or research needed to pick individual assets.

Active

Passive

✓ Choice of investment strategies to
suit your own financial goals
✓ Typically involve lower investment
charges
✓ Potential for above-average
investment returns, even when the
overall market is falling
✓ Less danger of significantly
underperforming the overall market

 

3. What we believe...

At M&G, we’re passionate about active investing, and for over 80 years we’ve built a strong reputation for investment integrity, original thinking and innovation. We are firm believers in the benefits of active management – but we also recognise that some investors will prefer lower-cost passive management.

In our view, both active and passive strategies can play a role in a well-balanced portfolio.

While the value of index-tracking funds will rise and fall in line with the broader market, a good active fund manager will be able to pursue opportunities that could perform well even if overall market values are falling.

Active investors can also be responsible investors. At M&G, we see part of our job as a responsible investor is to consider all factors which might materially affect long-term investment outcomes, including environmental, social and governance issues, and we can incorporate these into our investment decisions.

Important information

When you're deciding how to invest, it's important to remember that past performance is not a guide to future performance, and that the value and income from the fund's assets will go down as well as up. This will cause the value of your investment to fall as well as rise and you may get back less than you originally invested.

We’re not able to give any financial advice, and the views expressed in this article should not be taken as any kind of recommendation or forecast. If you’re unsure about the suitability of your investment, please speak to a financial adviser.