When to Use Active and Passive Funds in a Portfolio

Having the flexibility to implement investment ideas across the active, passive, and even smart beta spectrum is a very effective way to invest

Mike Coop 8 December, 2017 | 2:31PM

Often investors and their advisors set up active and passive investing as a dichotomy; either seek outperformance from actively managed funds or cut costs with passive solutions. However, depending on the objectives of a portfolio, we find value in making the most of both approaches by choosing the right fit to best express each investment idea.

Early thinking on the active versus passive funds decision was based primarily on the idea that active management has a greater chance to be effective in less-efficient markets. A Morningstar study found that the average small-cap manager was more likely to top its benchmark than its large-cap counterpart, and that the size of the outperformance was also on average higher than that of large-cap managers. Similarly, emerging markets equity managers were found to be more likely to outperform their respective benchmark than other developed markets equity managers.

Interestingly, the study also showed that the dispersion among returns for U.S. large-cap blend managers was much less than that for other equity asset classes. In fact, many of the asset classes in which the average manager topped the benchmark over the period also showed greater dispersion among managers. This suggested that skilled manager selectors might be able to more easily differentiate between future outperformers and underperformers in certain asset classes, making them potentially better suited to active management than others.

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The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

About Author

Mike Coop  is Head of Multi-Asset Portfolio Management, EMEA, Morningstar Investment Management

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