While the ‘active versus passive’ debate so often claims headlines across our industry, we believe both investing styles have pros and cons and both have important roles to play in successful multi asset investing. Here, Paul Nash, Multi Asset Investment Director, Fidelity International, explains how the two styles can be used in harmony across asset classes to benefit investors.
Why limit yourself to active or passive? Investors should not look at this as a choice between active or passive but rather consider how best to harness the advantages that both strategies have to offer.
We access markets through a combination of building blocks to best meet client investment objectives and preferences. When building portfolios, we consider both the best way to get exposure to a particular view we wish to express and the role each part plays in the portfolio as a whole. We believe that having as broad a range of options as possible is the best way to meet client objectives.
When to go active and when to go passive
Investor preferences about risk, return, cost, and time horizon are all important factors in deciding when and where to lean towards active or passive management. For example, investors who prefer to keep costs low tend to prefer a greater proportion of passive instruments, while investors who want to achieve specific return, risk or income objectives will often find active strategies better suited to meet their needs. Whether an investor is focused on absolute or relative returns will also play a role. For example, investors targeting absolute returns may find active management more attractive when market returns (beta) are expected to be poor.
Broad market conditions are also a key consideration. Active strategies have tended to perform better in periods of market turbulence because managers are able to manage positions dynamically based on incoming information and can make flexible use of cash and flows as dry powder when markets are under pressure if necessary. Passive strategies, however, are dictated by market capitalisation and only rebalance periodically, meaning flows cannot be dynamically managed, exposure is maintained for down moves, and opportunities arising from attractive valuations are missed.
Active strategies also tend to benefit from smaller stocks performing well relatively to the benchmark, whereas passive strategies are difficult to beat when larger stocks outperform, especially when market concentration is high. Passive funds can be a good way to gain exposure to the US and global sectors, which are well-covered from a research perspective and where index concentration is high (top 10 securities comprise 30% of the MSCI US index1). When markets are driven by sentiment, passive strategies tend to do well because active approaches are often managed with a bias towards fundamentals over price movements.
Finally, when market dispersion is high (when the variation between the returns of the individual stocks or bonds in an index is high) – active strategies tend to benefit because there is a greater opportunity for skilled investors to outperform the benchmark by selecting the best performing securities. We’ve seen examples of this over the years in some active funds investing across emerging markets. An example here would be the FSSA Greater China Growth Fund.
Pros and cons of active and passive
What are the benefits of active management?
- Beat the market: Active investing provides the opportunity for outperformance either by stock selection or asset allocation decisions, while passive investors will only get the broad market return minus costs. It should be noted that all asset allocation decisions are active, so that even tracking an index requires a choice to be made about which index to track, which can be a significant factor on overall investment performance.
- Flexibility: Generally, active approaches can invest more freely than their passive counterparts as they’re not tied to an index — this means that a particular client’s ethical or other requirements can be accommodated.
- Risk management: Active managers can minimise potential losses by avoiding certain companies, sectors or regions. Passive investors are required to accept an index, however constructed, and regardless of the quality or price of the underlying holdings of that index. Given that most indices are based on market capitalisation, it can lead to an emphasis on larger companies and sectors or paying up for those that are in vogue.
What are the benefits of passive investing?
- No underperformance: It’s unlikely that a passive fund will underperform the market index by a material margin. Active management, on the other hand, requires a lot of skill, especially in highly efficient markets, and underperformance is a possibility.
- Low cost: Management fees of passive strategies are usually lower than those of an actively managed fund. However, passive funds often come with hidden costs due to the potentially high cost of rebalancing. In many cases, the ‘headline’ fee rate can be misleading.
- Simple: Passive strategies offer a quick and easy way to gain access to a market; little additional research into manager style and skill is required.
- No key person risk: The process can be easily followed and doesn’t rely on any one individual, which can sometimes be the case for actively managed strategies.
The best of both worlds
Both active and passive approaches have strengths and weaknesses. Blending the two allows us to take advantage of both, offering a mixture of the potential for superior investment outcomes and lower costs depending on what our clients prefer. No two markets are the same, which means that the optimal way to access each will be different and can change over time. Remaining flexible allows us to pick the optimal approach given client objectives, market characteristics, and changing conditions.
We advocate taking a long-term diversified approach to investing. The Fidelity Multi Asset Allocator range and Fidelity Multi Asset Open ranges are good examples of diversified fund ranges which give investors the option to select the level of risk they are comfortable with. Both invest across asset classes and regions, supported by a well-resourced and experienced team of research analysts, and are not constrained to using only Fidelity managed funds.
Our Multi Asset Allocator range offers broad-based and diversified exposure to global financial markets, implemented using low-cost index trackers and exchange traded funds (ETFs). The Multi Asset Open range primarily invests in actively managed strategies and looks to capture alpha by analysing the broad drivers of markets, from macroeconomic and geopolitical dynamics to technical factors and market sentiment. Both solutions offer a globally diversified one-stop solution for investors but are complimentary in their approach to delivering a combination of capital growth and preservation.
1 FactSet as at 29th February 2024.
Important information
This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. The investment policy of these funds means they invest mainly in units in collective investment schemes. Fidelity’s Multi Asset funds use financial derivative instruments for investment purposes, which may expose the fund to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Changes in currency exchange rates may affect the value of an investment in overseas markets. Investments in emerging markets can also be more volatile than other more developed markets. The value of bonds is influenced by movements in interest rates and bond yields. If interest rates rise and so bond yields rise, bond prices tend to fall, and vice versa. The price of bonds with a longer lifetime until maturity is generally more sensitive to interest rate movements than those with a shorter lifetime to maturity. The risk of default is based on the issuers ability to make interest payments and to repay the loan at maturity. Default risk may therefore vary between government issuers as well as between different corporate issuers. Due to the greater possibility of default, an investment in a corporate bond is generally less secure than an investment in government bonds. Reference in this document to specific securities should not be interpreted as a recommendation to buy or sell these securities, but is included for the purposes of illustration only. Issued by FIL Pensions Management, authorised and regulated by the Financial Conduct Authority and Financial Administration Services Limited, authorised and regulated by the Financial Conduct Authority. Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited.
