Active vs passive investing – which is better?

At a glance

  • Active investing involves fund managers making active decisions over what to invest in. Passive investors look to replicate a given index or market.
  • Both strategies have their strengths and weaknesses.
  • Where appropriate we look to blend different elements of active and passive within our strategies.

During long periods where financial markets do well, the voice of the passive investor tends to be heard most loudly. These are periods in which it is relatively easy to deliver positive returns – the rising tide lifts all boats.

However, in more volatile times when markets are potentially flat or falling, as we saw in 2022, those who advocate active management tend to have a stronger voice.

In these tough periods, judgements that drive investment decisions can make the difference between disappointing and positive returns.

Which do we use?

When we are constructing portfolios and building our multi-manager funds, we look for fund managers who are expert at what they do at. We work with those we believe offer a disciplined investment process that will help them generate long-term returns for you.

However, we don’t just use active strategies within our portfolios. Not all markets are the same, and different investment styles may be more or less effective in different regions, asset classes and circumstances.

When thinking about the most effective ways of constructing a portfolio, we consider a broad range of investment choices. That means acknowledging the attractive features of active and passive investing – and all the shades that sit between them.

As a result, we are firm believers that there can be a role for active and passive investments.

Pros and cons

At one end of the spectrum sits the pure passive strategy, which simply replicates the constituents of a particular market or index. This should deliver very similar performance to the index that is being tracked, meaning you’ll experience similar returns, volatility, peaks and troughs as the index it aims to track.

One advantage of passive funds is they tend to be cheaper than active funds.

Overall, investors should receive broadly what they expect – market-like performance.

At the other end of the spectrum lies the genuinely active fund manager, who makes decisions on what to buy and sell based on an investment approach they will have developed over time.

This inevitably relies on human judgement but is supported by all sorts of technological and data-driven inputs that are designed to provide a competitive edge. Ultimately, we believe good active fund managers have the potential for sustainable long-term outperformance of the wider market, in excess of fees.

The downside is active strategies have a higher cost. Investors must accept the risk that they won’t outperform in all market environments and there may be prolonged periods where the fund underperforms the wider market.

In between these extremes lies a range of different strategies which use technology to make investment decisions using mathematical modelling rather than human judgements. This is known as ‘active quantitative management’. It can be delivered at a lower cost than a traditional active strategy, but it still retains the potential for better returns than the market will deliver, albeit with no guarantees.

What is right for you?

Depending on what you are trying to achieve, there could be a role for any or all these options within your portfolio. Our aim is to provide the broadest range of options to help you reach your needs and goals.

In pursuit of this aim, sometimes we blend different elements of passive and active investment together. We do this where we think you will benefit from having complementary exposure to the more attractive characteristics of both. In the modern investment world, therefore, you really can have your cake and eat it.

Get in touch

Whether you’re just starting out, or an experienced investor we can help you choose the right decisions that will help you reach your goals.

The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.

SJP Approved 20/06/2023