For investors, there are two primary portfolio management strategies: active and passive. It’s important to understand the difference in approach, and the advantages and disadvantages of each.
Active investing has a goal of outperforming a market index, benchmark, or target return. An active approach depends on anticipating market trends and irregularities through in-depth research, forecasting, and general expertise. A successful active manager must buy and sell with confidence – and be more right than wrong.
Unfortunately for most investors, only a small percentage of active investments outperform their passive counterparts. In addition, the more frequent trading behavior typical of an active strategy results in far more transactions, and inevitably far more fees for the investor – both for the trades themselves and the portfolio manager or team doing the research.
The main upside, of course, is that with the right moves, an active strategy may net larger gains.
Meanwhile, passive investing typically seeks to match the returns of a market index simply by replicating the holdings of the index. The passive approach is often better diversified and more transparent, as it tracks the returns of a market index closely through selecting the same stocks and securities.
Considering this, passive investments usually cover broad segments of the market and rely on upward movement from the overall stock market to generate returns. The reduced trade frequency and transactions also reduces fees to the investor; the tradeoff is that passive investments are not expected to beat their benchmarks.
Passive investing is increasingly popular among investors, and Alesco Advisors prefers to utilize passive investment vehicles for the majority of asset classes it includes in its client portfolios. Based on our ongoing analysis, empirical data, and academic research, we find that an index-centric methodology typically provides the best chance to achieve clients’ investment objectives.
Alesco Advisors selects best-in-class funds for each asset class, and, simply put, the best selection in most cases is a passively managed index fund. While there’s a place for active investing and portfolios can certainly succeed with using this methodology, it’s hard to ignore the fact that the vast majority of active investment funds underperform their benchmark over 5, 10, and 15 year periods.
Investors are better off avoiding attempts to select active managers that can overcome long odds, and should instead focus on selecting passive investments that can replicate the risk/return aspects of the market at a low cost. Value is added by combining the appropriate asset classes together in the proper weightings to produce attractive risk-adjusted returns at the portfolio level. Combine that with the tax benefits of passive management, and we believe this is the best strategy for our clients and customers.