When working with your Wren Sterling financial adviser, you may have heard or seen investments described as “active” or “passive”. You might have wondered exactly what these terms mean and why two different approaches to investments are necessary.
Gareth Hope, Wren Sterling’s Head of Research, explains what the terms mean, the difference between the two investment strategies and the affect they have on your investment portfolio.
What are the choices available to an investment manager?
When building a portfolio, an investment manager gets to choose where to invest across the globe, and how to invest in those areas. Each of these choices has two broad options.
Firstly, in terms of where to invest, or the asset allocation, a manager can choose to build a portfolio and maintain this (referred to as Strategic Allocation); or have the strategic allocation as the starting point and then adjust this as market conditions change (referred to as Tactical Allocation).
Secondly, once the asset allocation is decided on, the manager can choose to use investments that follow a market (index investing), or make choices about how to invest in a market (active investing).
Gareth Hope
Head of ResearchWhat’s the difference between strategic and tactical investing?
All investments are made in assets, such as property, bonds, equities and cash. Spreading your investments over these assets helps protect your portfolio from the risk of being invested in one area. The combination of these types of assets, and how often they are reviewed depends on whether your fund takes a strategic or tactical view of asset allocation.
At its most basic, the difference between strategic and tactical investing is frequency of change in the type of assets you’re investing in. Tactical asset allocation decisions are based on current market conditions, whereas strategic allocation looks “long term”.
If you consider the graph on the right, you can see that the overall trend for investment performance is a growing one. So it makes sense to take a long term view. However, you can also see that within the long term trend there are plenty of dips along the way and this is where a tactical investor will try to pre-empt the rise and fall in different asset classes to boost returns.
Tactical and strategic allocations can be cast as two opposing schools of thought, in reality these investing styles are more of a sliding scale as they’re both investing in the same thing.
What’s the difference between active and index investing?
Index investments follow market returns while active investments attempt to outperform those markets by buying and selling investments. Active funds often have higher fees, as they require investment managers to monitor and manage these funds in order to take advantage of any fluctuations. Their results can be good, but there is no guarantee.
Index-based management removes the risk of human error in stock selection. Index funds are traded less frequently, and often have less expensive management fees.
Why are these terms needed when talking about your investments?
These four quadrants help to understand where an investment manager seeks to add value to your investment portfolio. In the bottom-left ‘strategic index investments’, the manager believes that there is limited value in spending more on making changes to the investments and that obtaining market returns, and minimising cost, are the best way forward.
Through to the top-right, ‘tactical active investments’, where the manager believes that being able to change how the portfolio is invested can provide value.
The most appropriate approach will depend largely on your objectives and whether you feel that managers making changes can deliver outperformance of an index investment. Exponents of both strategies have amassed plenty of evidence to suggest their way is best, but as past performance is not a guarantee of future investment returns, there’s only so far one can read into this.
Related posts:
How our services are changing to meet client needs in a changing world
Financial planning is about more than just investment returns. Of course, they’re critical to financ...
Inflation, interest rates and what to do as an investor
As energy prices and the cost of production increase and bite on household wallets, what does this m...
Should we be preparing for long-term inflation?
Inflation could be here to stay, as problems with production in China, coupled with energy price ris...
How investors are supporting environmental and ethical causes
When many of us think about our legacy, many of us about how we will leave our assets to our familie...
Can I transfer my pension to another pension?
If you’ve had more than one job, you may have multiple workplace pensions and find it difficult to k...
Is uncertainty the new normal?
What's 'normal' in investing? Uncertainty. Investing in the good times and the bad, we look at risk...
Beyond ‘active’ and ‘index’ investing
Describing an investment as ‘active’ or ‘passive’ doesn’t fully explain how your investment manager...
How to avoid a pension scam
Pensions freedom has created many opportunities for scammers to target people approaching retirement...
https://www.cityam.com/cash-vs-stock-market-difference-returns-since-isas-began/
Data provided by FE. Care has been taken to ensure that the information is correct but it neither warrants, represents nor guarantees the contents of the information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Financial Express Limited Registration number: 2405213. Registered office: Hollywood House, Church Street East, Woking, GU21 6HJ. Telephone 01483 783 900. Website: www.financialexpress.net
The value of your investment can go down as well as up and you may not get back the full amount invested.