Active and passive asset management are two asset management philosophies, but they differ in many ways. Between promises of performance and reality, it is important to understand the differences, advantages and disadvantages of these two management methods.
The promises of active management
Active management has always been taken for granted when it comes to implementing an investment strategy. This management philosophy is based on the idea that, thanks to his sharp knowledge of the market, a manager will be able to outperform a benchmark index. The manager seeks to buy assets (e.g., stocks or bonds) that it believes will grow faster than the market, while buying them at the right time.
For example, the manager may aim to outperform the SMI index, the Swiss Market Index, which includes the 20 largest Swiss market capitalizations, by selecting and weighting securities differently than in the index.
Without going into too much detail, this idea is based on the assumption that the market is inefficient: the active manager considers that some of the available information is not incorporated into the assets price and that he can therefore take advantage of it to buy cheaply and sell at the best price.
On the contrary, if the manager assumed that the market is efficient, it would mean that the manager incorporates all available information into the assets price. The assets price is therefore the "fair price" at all times.
In return for this promise of outperformance: the costs of active management are three to four times higher than those of passive management. Indeed, this practice is very demanding in terms of market analysis and the manager wants to be remunerated for the promised performance.
On the basis of this information, the client can ask himself several questions: are there any managers who outperform their reference market? Will a manager who has already outperformed in the past continue in the future? Am I able to select these managers? Will I have access to my data and understand my investments?
Significant decline in performance
Intuitively, active management should find it increasingly difficult to outperform the market. Over the years, thanks to technological advances, information flows faster and faster and reaches an increasing number of people. As a result, markets are becoming more efficient, making active management less efficient. Indeed, it becomes more difficult for a manager to beat the collective intelligence of millions of investors with access to the same information at the same time.
This assumption is historically confirmed. An overwhelming majority of active managers fail to beat their benchmark. According to an article in the Financial Times, 99% of active funds that have tried to beat the US equity market index have failed in the past 10 years. Overall, when considering other indices, many studies show that 80% to 90% of active managers underperformed. Meanwhile, the high costs associated with active management continue to be charged.
Cette supposition est confirmée historiquement. Une écrasante majorité des gérants actifs échouent à battre leur indice de référence. D’après un article publié dans le Financial Times, 99% des fonds actifs qui ont cherché à battre l’indice américain des marchés d’actions ont échoué ces 10 dernières années. Globalement, si l’on considère d’autres indices, de nombreuses études montrent que 80% à 90% des gérants actifs ont sous-performé. Pendant ce temps, les frais élevés liés à une gestion active continuent d’être prélevés.
Worse, in 2017, Better Finance, the European Federation of Retail Investors, published the list of active managers whose performance is incredibly close to their benchmark, the result expected in passive management! This amounts to obtaining the result of passive management at a high price. The net performance inevitably suffers.
It remains to be seen whether it is possible to predict which active managers will outperform in the future. Again, this is an extremely difficult task and past (out)performances do not predict future (out)performances. In other words, a manager who has beaten his reference market for the past three years has very little chance of repeating it in the following three years. Feel free to consult the SPIVA study on this subject.
As a result, the following question arises: does active management still have a place in sound asset management? If so, on which markets?
Passive management, diversification and cost efficiency
Passive management, on the other hand, will not seek to "do better". It follows a benchmark index with the objective of replicating its composition and, consequently, its performance. Less demanding in terms of constant research and analysis, this management philosophy costs much less.
Vehicles implement this philosophy and are available for many benchmark indices. These are ETFs (Exchange-Traded Funds) or trackers. They offer a huge saving of time and money. First, because by buying an ETF, it is possible to invest in a region of the world without having to buy each security individually. Secondly, because they are about 5 times cheaper than "traditional" active funds.
On the scale of a multi-asset portfolio, the manager convinced by a passive approach will focus on building a portfolio that is viable over the long term, diversified and therefore robust in case of temporary financial crises. This also results in a lower total cost much more adapted to the portfolio's expected return.
Not only is passive management efficient and less costly, but it is also more understandable and accessible in its presentation to commercials, companies and individuals.
Warren Buffett, a famous American businessman and investor, recommends passive investment!
A possible cohabitation?
Fyleen, Lean Wealth Management believes that active management can make sense in less liquid and/or niche markets, where information is slower and harder to get (e.g. unlisted companies, unlisted debt, real estate, etc.).
That is why we offer passive management for the majority of our clients' assets: a diversified and robust core portfolio that forms the backbone of their investments. It is a solid base of equity and bond ETFs covering all regions of the world.
Fyleen then suggests actively managing a smaller portion of these assets in satellite investment opportunities.
For more information on our offer, you can contact our advisors on 022 539 18 39 for a personalised study of your assets or via this form. We will be happy to contact you.