Over the past two decades, investors have increasingly turned from selecting actively managed mutual funds to embracing passive market exposure through exchange traded funds (ETF). This often led to a contrived debate about whether active or passive investing was better or more effective. Read more to see why positioning passive investing as contradictory to active investing was always a misrepresentation of the truth.
Passive Investing Requires Active Decisions
An ETF is an investment vehicle originally designed to inexpensively obtain exposure to certain asset classes. In putting an investment portfolio to work, you or your advisor must make active decisions. To what asset classes do you want exposure? You could employ a geographic filter, or slice and dice markets in any number of ways to suit your needs. Which ETFs will you use? This is no small matter as there are more publicly traded ETFs now than there are stocks. If you thought selecting from the bewildering array of ETFs would be easier than stock picking, think again. And how many dollars should you place in each instrument? You might put an equal amount in each instrument, or differing amounts that consider the risks and your goals. We share more in a separate article, but there is nothing passive about investing.
Advisors are Investment Managers Now
In an era where investors can access any publicly traded investment themselves, advisors are choosing to become the investment manager. This serves two purposes. One, by using less expensive investment vehicles, an advisor reduces the fees paid by their client. For an advisor charging 1% in addition to a 1% mutual fund fee, using ETFs that charge 0.2% helps client reduce the overall fees coming out of their pocket.
Two, acting as the investment manager helps the advisor demonstrate the value they add for their 1% fee, something ETFs have helped to simplify. In the past, becoming the investment manager required skill and infrastructure to analyze, implement and monitor portfolios made up of individual stocks and bonds. Most advisors couldn’t shoulder this cost. The advantage for advisors in using ETFs is that they are now granular enough to gain specific exposures while diversified enough to avoid the cost pressure of analyzing each individual security. If advisors are becoming investment managers to justify their costs, we are reminded of the first bullet above. This leads to the next logical question, just how good is your advisor as an investment manager?
Passive Management is Declining
Every year the Journal of Financial Planning and the Financial Planning Association conduct a Trends in Investing Survey. Between active management, passive management, or a blend of the two, advisors were asked which provides the best overall investment performance while taking costs into account. The majority of advisors, 66%, continue to favor a blend of active and passive management. However, only 24% of the 2020 survey respondents said passive management provides the best overall investment performance, down from 29% in 2019. Even fewer advisors belief fully passive exposures is best.