A case for closing the historical divide between passive and active – Oliver Wallin, Solutions Portfolio Manager at Franklin Templeton Investment Solutions (FTIS) is in support of a blend of both worlds.
Often thanks to some pretty lazy generalisations, investment approaches have long been divided into two opposing schools. One has been perceived as wide but shallow, the other as deep but narrow.
The principal occupants of the first camp have been passive management and quantitative analysis. The principal occupants of the second camp have been active management and qualitative analysis.
To say such distinctions might be unduly sweeping would be an understatement. In reality, all sorts of nuances have been at play for decades.
Yet the underpinning notion of width, shallowness, depth and narrowness is extremely important for investors.
Understandably, many would like their portfolios to conspicuously reflect the two overtly positive attributes among the four.
Efforts to realise this ideal have gathered pace of late. Product providers have recognised that there’s a gap between passive and active, between quantitative analysis and its qualitative counterpart, and that plugging it ought to be high on their collective agenda.
We believe the innovative use of factors is key to filling the void. By combining the predictive power of systematic models with the unrivalled acumen of bottom-up research, it should be possible to give investors the best of both worlds. So how exactly might this be done?
Factoring in fundamentals
There was a time when only one factor, market risk, was deemed worthy of consideration when building portfolios.
Subsequent advances revealed the existence of multiple factors, shedding ever more light on their contribution to improving returns and mitigating volatility.
Today, in our opinion, a compelling way of seeking to accomplish these inextricably linked goals is to utilise active managers’ proven stock-picking skills in a systematic context. In essence, the challenge is to transform a raft of fundamental insights into a factor that can be incorporated into a systematic approach.
Our own Core Enhanced Equity Funds aim to do this by employing five factors: quality, value, sentiment, alternative and conviction.
The first three can be thought of as “traditional”, while the fourth makes use of unconventional data sources that have low correlation to traditional factors.
The fifth factor, uniquely, is extracted from our active managers’ research-intensive stock selection. Its objective is to introduce more idiosyncratic return drivers by drawing on managers’ holding lists.
The process is still algorithmic, leading to aggregated “conviction scores” for all the equities in a given investment universe.
We expect this innovation to be meaningfully additive in terms of both potential alpha generation and through its diversification benefits. In our view, it’s a potent means of delivering width and depth alike.
Crucially, sensational outperformance isn’t be a priority. For our Core Enhanced strategies, under normal market conditions, we operate within a tracking error of 1-2%, seeking above-market returns but with strictly limited deviation from underlying indices.
Reshaping investor thinking and portfolio construction
The quest to plug the gap between passive and active has significant implications for portfolio construction. For investors, perhaps first and foremost, it can help better frame the concept of risk.
By way of illustration, imagine a fund of this kind sits at the centre of a portfolio – as our Core Enhanced strategies are designed to.
This should free up extra “risk budget”, which might then be devoted to active managers whose funds are more heavily geared towards market-beating performance.
For the investment industry as a whole, meanwhile, the clear message is that portfolio construction must keep evolving.
As investors’ requirements and expectations change, we have to continue to identify and meet unmet needs.
Passive exposure has been the weapon of choice for a rising number of investors in recent years.
The Investment Association’s latest annual survey reports that funds under management in index trackers reached a record high of £383.7 billion for the UK retail market in 2024, with institutional use also on the up[1].
These passive instruments often form the core exposure to a market within broader portfolios, yet today there’s growing acknowledgement that such exposure could – and should – be made to work a little harder.
This is where both rules-based, quantitative investment strategies and active management can play a more meaningful role in generating returns and controlling risk.
All this supports the case for a blend of the best of both worlds. It’s not a matter of replacing existing products: rather, it’s a matter of adding to and complementing them.
By reducing or even closing the historical divide between passive and active, maybe we can at last render lazy generalisations a thing of the past.
[1] See, for example. Investment Association: Investment Management in the UK 2024-2025, October 2025 – https://www.theia.org/industry-policy/research/investment-management-survey-files.
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The writer’s views are their own and do not constitute financial advice.
This information should not be relied upon by retail clients or investment professionals. Reference to any particular investment does not constitute a recommendation to buy or sell the investment.
Main image: blend, background, philipp-hubert-ZCexKfnqDdw-unsplash
