Active v passive: The great debate

In financial markets we like important “stuff” to be prefaced with “The Great....”.  First we had The Great Depression (1929) - in more recent years The Great Recession (2008) and The Great Rotation (2013).  One of the most polarising arguments for investors, advisers and product manufacturers is the question of whether returns from active or passive strategies outperform - this should be labelled “The Great Debate”.

What is active?  What is passive?

A passive strategy essentially “buys and holds” the market it invests in.  A passive international equity investment could for example buy all 500 stocks in the S&P500 with the same weightings as the index. A passive domestic equity investor could buy all 50 shares in the NZX50 index.  A true passive investor will continually rebalance holdings as companies and weights in the index change.  The passive investor would also remain 100% invested in these shares whether the market is rising or falling – seeking a portfolio returning exactly the same as the market return (whether good or bad).

An active investor will deviate from passive portfolio holdings.  An active portfolio may look nothing like the index – with fewer and more concentrated exposures. Or it may have some resemblance to the index – changing company weights or including others from the wider universe.  It may buy and sell frequently or just when markets seem to be trending up or down.  It may also use cash holdings and derivatives for protection.  The aim will be to deliver higher returns and/or lower volatility than the market.