When working with your Wren Sterling 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 portfolio.
What’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.
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The value of your investment can go down as well as up and you may not get back the full amount invested