The information included in this recording is general advice only and has been prepared without taking account of your objectives, financial situation or needs. Please refer to the full disclaimer at the bottom of this page.
Let’s kick off with just that – what is the difference?
A passively managed or index fund, somewhat as the name suggests, is managed so that the fund replicates or matches the return and characteristics of the relevant index.
This is the same across all asset classes.
For example, an index Australian share fund will aim to match the characteristics and return of an Australian share market index – such as the ASX300.
If we’re talking about fixed income, the index fund would aim to match or again replicate the related fixed income index, such as the Bloomberg Australian Bond Composite Index.
An actively managed fund is where active investment decisions are made. The fund can, and will, deviate in its holding versus what it represents within the related index.
In the example of an Australian share fund, active decisions are made to only hold or invest into certain stocks and to also vary the size or amount of each stock held relative to its size in the index.
Why would an investor use one over the other?
Good question. There are merits to both and it often depends on what an investor’s overall objectives are, along with the asset class in question.
I see there are three key items to consider.
- What’s the investor’s objective? What do they want from their investments?
- What are the fees or the related cost?
- Which asset class is in question?
Can you talk us through the investor objective?
The more specific or defined the investment objective is, the more likely the need for an actively managed fund.
If someone is simply seeking the market level return and characteristics delivered by an asset class, such as the ASX300 for Australian shares, then an index fund will do this.
However, if the investor wants or needs something different to this, such as an effort to have more of the return in the form of income or perhaps have a bias towards a particular characteristic or type of stock, then an actively managed fund would be needed to achieve this.
What about fees?
Index funds typically have a lower management fee than actively managed funds.
As no active assessment or investment decisions are made in managing an index fund, a comparatively smaller investment team is required.
In relation to an actively managed fund, the investment team will usually conduct assessment and analysis of individual shares as well as the macro-economic environment. In order to undertake this work and assessment, the resources and level of staff involved is greater.
This is one of the key ingredients as to why an index fund is often able to be offered at a lower fee level than an equivalent actively managed fund.
Do you think this difference in fees impacts how attractive each strategy seems?
Yeah, I think at times it does. While many people may not understand all the technical elements of a managed fund, they certainly understand fees. It’s nothing new to compare or understand that there are lower, higher and mid-priced products.
Regardless of the product, I think that some people are either attracted or perhaps pre-disposed to a certain point on the pricing spectrum.
It’s like someone looking at a wine list, or different tennis rackets. Many will not necessarily go for the very cheapest or lowest cost product, but perhaps one or two products up from that which has the lowest cost. Personally, I believe that some people are pre-disposed to do this when looking at most products, including investment funds.
Equally so, I think much of the price decision for any product has some relationship to the person’s level of understanding and knowledge of the product itself.
As the level of understanding or insight increases, so does the capacity to understand and see, or determine value in different priced products.
Otherwise, if little understanding or benefit of product features and functionality is held, the more likely someone may be to purchase at a lower price – or in this instance, fee.
Is this discussion of active versus passive the same across all asset classes?
Both types of funds are available across all asset classes, but looking at historic returns it seems there is a little more merit for actively managed funds in outperforming and adding value in some asset classes over others.
According to the Zenith Research performance surveys to the end of May 2018, in a broad sense the median performing actively managed fund tended to outperform more often within the growth asset classes – such as shares – than they did within the defensive income based asset classes, like fixed interest.
But the outcome of which is the better performer can and does move around over shorter term timeframes.
The argument or question of which is better has been around for many years and I’m sure will continue to be asked for a long time to come.
However, remember both can be used together. As we discussed, investors need to be clear on what their purpose or objective is and select funds that best align to achieve this.
That brings us to a close for today – we’ll talk more about the difference between active and passive investing in our next episode. We hope you enjoyed this podcast, and encourage you to visit bennelongfunds.com for more insights from the team.
This recording is provided by Bennelong Funds Management Ltd (ABN 39 111 214 085, AFSL 296806) (BFML). The information provided is general information only. It does not constitute financial, tax or legal advice or an offer or solicitation to subscribe for units in any fund of which BFML is the Trustee or Responsible Entity (Bennelong Fund). This information has been prepared without taking account of your objectives, financial situation or needs. Before acting on the information or deciding whether to acquire or hold a product, you should consider the appropriateness of the information based on your own objectives, financial situation or needs or consult a professional adviser. You should also consider the relevant Information Memorandum (IM) and or Product Disclosure Statement (PDS) which is available on the BFML website, bennelongfunds.com, or by phoning 1800 895 388 (AU) or 0800 442 304 (NZ). BFML may receive management and or performance fees from the Bennelong Funds, details of which are also set out in the current IM and or PDS. BFML and the Bennelong Funds, their affiliates and associates accept no liability for any inaccurate, incomplete or omitted information of any kind or any losses caused by using this information. All investments carry risks. There can be no assurance that any Bennelong Fund will achieve its targeted rate of return and no guarantee against loss resulting from an investment in any Bennelong Fund.