Carolyn Black: All you need to know on Active versus Passive investing

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With summer in full swing and holidays away from the office on many people’s minds, perhaps we should not be so surprised that the issue of Active versus Passive investing has once again reared its head.

As volumes and activity on the stock markets traditionally fall over the summer, some investors take the decision to position their portfolios in low cost tracker investments before they jet off to sunnier climates, where their portfolios may not be as accessible as they are at other times of the year.

Passive, or tracker, investments aim to deliver an in-line market performance by replicating the movements in the markets that they are tracking. Conversely, active investing involves selecting investments which have the potential to deliver a superior performance to that of a selected benchmark or index. Passive investments traditionally perform well when tracking an efficient, well researched market, for example the FTSE 100 and, during periods of market stability. Conversely, active investing is called for to ensure that investors achieve returns in less predictable markets, such as Emerging Markets, or when markets are volatile or lacking conviction.

It is this latter scenario which we believe supports the use of active management strategies. Currently, markets are shrugging off bad news and uncertainty, with investors holding onto the belief that the strong market performance will continue indefinitely as unemployment and interest rates remain low. Major events such as the triggering of Article 50 and the General Election, hardly ruffled any feathers! This optimism is leading to overheated markets, especially in defensive stocks which investors are turning to as a home for cash. Ultimately, there will be a reversal in the markets, though it is difficult to predict when this will take place, how quickly it will happen or what the initial catalyst for the change will be. When the correction comes, it is likely that over-bought growth stocks will reverse quickly and savvy investors will move swiftly into value stocks, or geographic regions, which have been out of favour for quite some time and which are looking cheap.

Investors following passive investment strategies could be left exposed when the markets change direction as their portfolio weightings will take time to catch up with market positioning. A sudden intra-day fall in the index could lead to a dramatic underperformance of passive versus active strategies. Likely, active portfolio managers will have spotted the catalyst for change on the horizon and will have positioned their portfolios ready to take advantage of the shift in market sentiment, so leaving their clients free to sit back on their sun-loungers and enjoy their holiday, safe in the knowledge that their investments are not being left to the whims of a faltering bull market.

The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Investors should refer to their financial adviser to ensure that our service is suitable for their investment needs.