Passive Versus Active Investing
One of the biggest investing debates revolves around passive versus active investing.
Passive means investors will buy an index fund or exchange traded fund. These funds follow a basket of stocks. Active investing is when money managers go into the market and actively buy and sell shares.
Investors of both camps believe they hold the key to long-term returns.
On average, passive investors usually win the debate. The results show that the vast majority of active managers underperform passive strategies over the long term. It also doesn’t help that active managers charge fees far larger than low cost indices.
It’s why so much capital pours into passive funds. According to Morningstar, around US$505 billion went into passive strategies in 2016 in the US.
Passive Will Keep Getting Bigger
It should come as no surprise then that Vanguard’s chief investment officer, Greg Davis, says passive investing will keep getting bigger.
As reported by The Australian Financial Review:
‘Vanguard’s Mr Davis said the decisive shift from active to passive funds management would persist due to the lower costs.
‘“In an environment where bond yields are somewhat depressed, forward looking equity returns are expected to be somewhat lower given the starting valuations, investors are gravitating towards lower cost options,” he said.
‘Financial advisers and some individual investors had shied away from picking individual stocks since the 1980s and 1990s and there was greater focus on diversified asset allocation, he said.
‘Vanguard’s assets under management have surged to nearly $US5 trillion, including about $US1.2 trillion of funds that are actively managed by professional stock and bond investors.
‘Investment companies offering index funds and publicly traded ETFs have branched out beyond traditional market benchmarks such as the US S&P 500 and the local S&P/ASX 200.
‘They now include the NYSE FANG+ index of 10 internet and media companies such as Facebook and Tesla, a whiskey distillery ETF and ETFs based on US companies that may benefit from Republican or Democratic Party policies.
‘Asked if some ETFs were becoming too exotic or risky, Mr Davis said factor investing or so-called Smart Beta incorporated a portion of active management.
‘“To the extent you have any deviation away from the market that’s some form of active,” he said.
‘“Narrowly defined sections of the market, it is buyer beware and people need to understand the risks.”’
Intelligent Portfolio Selection
Of course, this doesn’t mean that passive investing is the best investment strategy. Intelligently selecting a concentrated portfolio of cheap businesses easily beats the market over time.
For example, if you wanted to outperform the ASX 200 over the last 17 years, all you had to do was hold five stocks which, on average, returned more than 90% over the same timeframe.
You didn’t have to buy highly-speculative stocks that could have tripled. You could have bought five of the largest stocks on the market.
For example, say you bought the following on 28 November 2000:
Source: Markets & Money
Had you put $2,000 into each on 7 April 2000, you would have turned $10,000 into $42,648. That’s $23,508 more than you’d receive had you put $10,000 into an index fund tracking the ASX 200 over the same timeframe.
So while passive investing isn’t the clear winner when it comes to long-term returns, it can potentially be a safer option than leaving capital with an active manager.
Junior Analyst, Markets & Money
PS: Aussie property prices continue to defy gravity. Those who have tried to predict the top have been wrong up to now. That’s because property prices still have a long runway of growth ahead.
If you want to read more about long-term booming property market, check out our Markets & Money report, ‘Why Australian Property Is On The Verge Of A Decade Long Boom’.