Tag Archives: Passive management

Active and passive management: an endless discussion

Passive management categories in T-Advisor

The boom of ETF in the investment landscape as a new kind of asset opened the endless discussion about active and passive management. First of all, what do we mean when we speak about both ideas?

Traditionally, the active approach means that a fund manager or a team design a specific fund or portfolio composed by a basket of assets. These assets are selected by the product profile (different kind of risk, asset categories or market). Then, the manager tries to beat a specific index or benchmark. The task is hard, because the manager has to deal with a lot of information related to companies, markets, policies and general trends. To attempt to outperform, the manager buys and sells regularly to improve the results.

On the contrary, the passive approach creates a portfolio or fund that copies the same structure as a specific index. That means that the result is narrowly linked with the index. Instead of outperform, the passive management obtains the same returns as the benchmark. The task of the manager is quite lighter, because he only adjusts the portfolio every certain time depending the changes in the index composition.

The question is: what is better? A usual pitch explained by passive management supporters is that active managers have a low rate of success outperforming the market, which is actually true, if we see some statistics. Usually, ETFs even beat the active manage funds. Other arguments are related to the costs: while passive management has low fees, active management costs quite more, because there is a human group behind the portfolio. Passive products are also easier to understand and agree the idea of diversification to reduce risks.

The current roboadvisor trend is based on ETF and passive management. However, it is reasonable to speak about different degrees of active management, as the financial adviser and blogger Cullen Roche proposed in his blog. Passive investing has a reduced degree of active management, but it is fair to say that the operational structure is quite lower as a traditional fund manager.

It is difficult today to defend active management, because they fail regularly in its aim of beating the market and the costs are higher. We don’t mean that it has to disappear, but it will surely evolve to a model in which technology will play a stronger role to reduce costs, so that traditional funds can compete again. Roboadvisor platforms can be a solution. The current movements in the markets are showing it, because great banks and managers are buying roboadvisors or developing their own algorithmic platforms.

ETF, the asset revolution has consolidated

Exchange Traded Funds, or ETF by its initials, are the trendy security in the last years. Their assets have doubled in the last five years, as this BlackRock chart shows, although there is a reduction in January 2016, because of the general volatility of the equity markets:

Global ETP assets by year. Source: BlackRock

ETF are there to stay. There will be no reversal. In this short history (although they exists since the end of the 1980’s), there have been a few entities that have specialised in creating and selling these products: iShares by BlackRock, Vanguard and State Street, as the following table shows:

Global ETP providers. Source: BlackRock

But why are ETFs so successful? Why is there an offer from a few to 1,800 different products in so short period of 10 years? Flexibility, low fees and trading like stocks are some of the advantages against traditional mutual funds. Although there are also some disadvantages, investors still look at them as a very attractive asset. The explosion of them as a business contributed to create a long list of specialised media in Internet, because professionals and individuals have been looking continuously for information about them.

The design of an ETF is very different depending the cases: equities, fixed income, money market, commodities… They replicate an index or track a collection of securities or sectors in the known as passive management. After creating the product, there are only some adjustments every certain period, but the product performs independently of the manager.

In T-Advisor, our Watchlist has a long list of ETF categorised by their strategy for our registered users:

T-Advisor ETF Watchlist

It is just an option, but it is interesting to consider because of its price transparency linked with diversification. You invest in a diversified product, that means that you reduce some risks, and you have steady information of the price fluctuation, against mutual funds, whose prices are updated when markets are closed. In costs, they are cheaper than mutual funds. Yes, they are more expensive that a share, but you have to consider the above-mentioned diversification.

This is probably the reason of the success: the combination of the flexibility and transparency of a share and the diversification of a mutual fund. A survey conducted by EY in 2014 already talked about the promising future of ETFs amongst wealth managers and invertors. That future is already here.