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Active and passive investments are often regarded as opposing strategies – and as an investor you have to pick a side.
A passive investment — such as an exchange-traded fund — tracks an index. The idea is to simply let the market’s performance generate the investor’s returns. It’s a hands-off approach that requires limited research or in-depth understanding of the underlying securities.
Active investment, on the other hand, calls for a portfolio manager to buy and sell securities in keeping with the investment objectives of the fund and monitor them regularly. The ultimate goal of any active manager is to beat the benchmark index it is tracking over time – by identifying opportunities and minimizing risks.
Looking beyond the benchmark
When considering a passive investment, it’s important to examine the index you’re tracking. A closer look at the index that tracks the Canadian equity market, for example, reveals that the vast majority is made up of financial institutions, resource sector offerings and energy companies.
“As much as 65 cents of every passive $1.00 dollar invested in the S&P/TSX Composite Index is exposed to companies in just two industries: banks and resources,” explains Myles Zyblock, Chief Investment Strategist at Dynamic Funds. “This spells a great deal of trouble when these two industries fall out of favour at the same time.”
On the flipside, health care makes up about 1 per cent of this Index, according to Mr. Zyblock, which means that passive investors would have limited exposure to this sector.
“An active manager is not handicapped by the artificial construction of the Index,” explains Mr. Zyblock, “and can look elsewhere for opportunities or weight portfolio holdings in accordance with the risk profile of the company or industry.” Not only can the active management approach help avoid catastrophic losses through diversification, but it can also boost returns during robust market cycles.
Why active matters now
Active and passive investments can also be impacted differently depending on what phase of the market we’re in. “For most of the prior decade — perhaps, because of lingering financial trauma from the 2008 crash or extreme policy interventionism — most stocks tended to move up and down together, independent of their fundamental merits,” explains Mr. Zyblock. However, the market appears to be returning to normal. “Now stocks with good fundamentals are generally doing well, while stocks with bad fundamentals tend to perform poorly.” But only active managers can take advantage of these differences.
As Mr. Zyblock explains, most active managers are ready for a market shift, as volatile markets tend to allow active strategies to perform best.
“Active managers are equipped with a toolkit. Each of us are searching under rocks for gems, opportunistically deploying or raising cash during periods of market stress, or managing risk through the use of options and futures. These all represent important tools that can generate key returns and rewards over time,” says Mr. Zyblock.
Best of both worlds
Most financial advisors realize that the key to building a solid investment portfolio is not to think in such black and white terms — but to employ both active and passive strategies in an investor’s portfolio, at the right time, to provide a more comprehensive approach to limiting risk and maximizing return potential.
Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Views expressed regarding a particular company, security, industry or market sector are the views of the writer and should not be considered an indication of trading intent of any investment funds managed by 1832 Asset Management L.P. These views should not be considered investment advice nor should they be considered a recommendation to buy or sell. Dynamic Funds® is a registered trademark of its owner, used under license and a division of 1832 Asset Management L.P. ™Trademark of its owner, used under license.
This content was produced by The Globe and Mail’s Globe Content Studio, in consultation with an advertiser. The Globe’s editorial department was not involved in its creation.