Active and passive investing

Ayabonga Cawespeaks with Investec's Lisa Stride and Fabrice Muhizi.

What is the difference between active and passive investing?

Active vs. passive investing

The central difference between the two investment approaches is around how often managers make investment decisions and review the portfolio.

Passive investing tracks market-weighted indices or portfolios whereas active investment follows a more hands-on approach. The latter involves a team of research analysts and portfolio managers that construct a fund or portfolio with a certain mandate. The main objective is to beat the market benchmark. Active managers make investment decisions on your behalf, which is also why these funds come with an extra, but justifiable cost, given that the fund outperforms the market.

Chasing alpha

Alpha is the excess returns earned on the investments above the market benchmark. It’s the bottom line for active investment management. Fund managers achieve alpha by continually analysing markets and accordingly shifting client’s investments to benefit from their findings.

Passive investing is the cheaper of the two approaches but these fees are justified if fund managers are continuously beating the market.

In many cases, passive funds outperform active funds in the long run, but there is a subset of active fund managers that have been able to show results in the long run. You want to invest your money with these managers. A passive investor can’t outperform the market, as their return is the market benchmark minus the fees.

So, active or passive?

Decide upfront which type of investor you are. Do you have the time and expertise to go it alone? Do you want to own the market or have something more tailored to your risk profile? In these volatile times, active management may be a better choice for investors new to the scene.

Before investing, do your own research about what you’re getting into. If you’re paying for a service, such as active management, it must be justified by the value provided. You also don’t have to stick to one approach, there’s a place in a portfolio for active and passive managed funds.