• The Listener
  • North & South
  • Noted
  • RNZ
Ainsley McLaren. Photo/Supplied

The difference between active and passive investing

The words “active” and “passive” are used often in investing, but are you sure you understand them?

All too often, Kiwis focus solely on the fees they pay for an investment, says Ainsley McLaren, Executive Director at Harbour Asset Management. It’s important to think about the investments that make up your funds, and whether they will do what you need them to do through good and bad times.

Passive or active: what’s the difference?

Put simply, passive investing minimises buying and selling of investments, which reduces running costs. As a result passive funds tend to have lower fees.

A typical passive fund often mirrors all of the investments in a certain index such as the NZX50 or FTSE100. These are called “index” funds and hold all, or a representative subset, of the companies in that index.

Active is where professional fund managers select investments that may earn better returns than the index over time. The managers can be nimble and flexible and choose investments better able to ride the ups and downs in volatile times. Active funds tend to have a wider variety of fees, depending on what they invest in.

“The active versus passive investment debate has been around nearly since Adam,” says McLaren. “In the US, around 20% of money invested is passively managed and 80% is actively managed. Many investors blend both styles.”

One of the reasons that passive investing has been popular in recent years may be that markets have on the whole boomed since the GFC. Index and other passive funds have tracked up with them.

If markets start to head downwards, that’s when Kiwis with active investments may really see the value in their choice. Their active fund managers should have already identified investments with good outlooks even in troubled times.

Fees are secondary

McLaren says the issue of fees is not the number one consideration when choosing the right fund for your personal situation.

“First you need to know your risk tolerance, which helps you choose between conservative, balanced or growth type investments. That choice will drive around 85 – 90% of your returns over time,” she says.

Fund managers such as Harbour have a range of funds on offer to meet most needs. If you want a low fee index-tracking fund for example, Harbour has the New Zealand Equity Advanced Beta Fund, 70% of which is invested in an index and 30% invested more actively.

“At the other end of the range we have more actively managed funds, such as Harbour’s Australasian Equity Focus Fund, which holds a smaller number of companies reflecting our best ideas based on research,” says McLaren.

Likewise, with bond investments – the more active end of the spectrum includes funds such as Harbour’s NZ Core Fixed Interest Fund and, for a lower fee option, there’s the Harbour NZ Corporate Bond Fund.

When investing isn’t your day job

Not everyone’s nerves can take downturns. Whether active, passive or a mix, try to choose your funds well and put them in the bottom drawer, says McLaren. Chopping and changing because you’re tracking your investments minute by minute on your smartphone can leave you worse off.

Good fund managers live and breathe portfolio theory, behavioural finance, performance measurements and other tools of the trade. Let them do the worrying for you.