The debate on active vs. passive investment strategies is never ending. If you google active vs. passive there are tens and thousands of articles on the topic.
For less informed readers, passive investment strategies refer to tracker or index funds, which are designed to track the performance of an underlying market or index. There is no active management. Very briefly the general argument for passive vs. active is lower fees and the fact that the average global manager fails to beat the market after fees.
Passive investment strategies have gained momentum post the 2009 global financial crisis (GCF) as active managers struggle to keep up with market indices, which seem to reach new highs on a weekly basis. Increased regulation post GFC has also seen a greater focus on investor transparency and in particular fees, which are under pressure. Many advisers are now including passive investment strategies in their client portfolio’s to reduce the total overall cost to clients.
Looking back in the “rear view mirror” this was certainly a good idea 6 years ago, but I would argue that now, might not be the right time to be buying your “garden variety” capitalization based index fund i.e. Satrix 40.
Shares (companies) are included in the index based on their total shares in issue multiplied by their current share price. So by implication you are investing in those shares, which have gone up the most and are therefore possibly the most expensive; thus risking permanent loss of capital when the market loses momentum, which is a nice way of saying crashes!
To quote the most successful investor of our time and in my opinion the best description to explain current markets conditions, over to Mr. Warren Buffet:
“The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behaviour akin to that of Cinderella at the ball. They know that overstaying the festivities – that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future, will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore giddy participants all plan to leave just seconds before midnight. There’s a problem though: They are dancing in a room in which the clocks have no hands.” Warren Buffet
When you invest in an index your fellow shareholders are those so eloquently described above and you can be assured, when the going gets tough they will be gone. Not the business partners you want as a long-term investor.
Good active managers with disciplined investment philosophies underpinned by valuation carry their own time pieces and thus know when to leave the party.
Mcomm, CFP®, HdipTax
T. 021-851 3746