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.