Passive Investing - Myth Or Reality? Part 2

by: S&P Dow Jones Indices

By Koel Ghosh

Active management, success always?

As we discussed before, the success of active management is directly related to its outperformance of the benchmark it is comparing itself with. In order to ensure consistency, active managers are reluctant to deviate from standards that include this comparison. This leads them into situations where they may have to hold a position that may not necessarily be attractive to them, or there may be excessive movement of positions in the portfolio, resulting in additional costs and turnover. Hence, a fund manager's choice and conviction play a part in active strategy. However, this being an individual choice brings in bias, which may work in certain market conditions and may not in others.

Another aspect to consistency is fund manager continuity. Market participants get accustomed to a certain level of expertise provided to an active product by an expert fund manager. However, change being the only constant results in movement of fund manager capabilities. This may also disrupt the consistency of the investment product in following particular return patterns.

For those looking for a certain return trajectory, passive investing may be the preferred solution. This also applies to those who are not vigilant on the consistency of fund manager or product continuity, or who are not able to track the market conditions on a day-to-day basis.

Say a market participant who wants to invest in the manufacturing sector can easily buy into a product based on a manufacturing index. This enables consistent and relatively cheap access to the sector. Furthermore, there is a wide range of choices beyond sectors. Factors offer the option to invest in stocks via the factors that may be preferred. Passive investments offer a host of factors, such as growth, value, dividend, low volatility, momentum, etc.

In this evolving paradigm, with market participants growing more savvy and passive investments offering a host of options, the opportunities this space offers is definitely growing.

A famous quote by Mark Twain stated, "It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so." So can we state for sure that active management is superior? Maybe we should give it a bit of thought!

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