Anyone who chooses to use funds to access the stock market will have a choice between so-called ‘active’ and ‘passive’ funds.
Active versus passive
Active fund managers believe that their superior skills and insights can identify the best stocks and eliminate those on a downward trend. They think they can find a bargain. Spot the dog before others. Identify the region that is heading into difficult times.
On the other hand, passive funds do not involve this degree of subjectivity. No-one makes a call on whether Share A is better than Share B. They simply follow what we call an index, or a list of shares or bonds in any given market. Passive funds will buy investments in proportion to their size and no judgement calls are made.
These funds are typically cheaper to manage and to buy because they do not require the same intensive human involvement and brain power!
An example (for illustrative purposes only)
Let’s compare an active fund which invests in UK shares with a passive UK share fund. In our example, the passive fund will track the FTSE 100 index.
At time of writing, HSBC is the largest share in the FTSE100 and makes up about 7% of this collection of 100 shares. So if you invest £100 in a FTSE100 passive fund, you will have approximately £7 worth of HSBC shares. And no-one will read their reports, look at their numbers or grill their directors in the process.
An active manager will do all of the above and make a decision on how positive they feel about the outlook for the company. If they don’t like what they see, they will not invest as much as £7 of your money in this company. They may leave it out of their portfolio altogether. This would be described as being ‘underweight’ HSBC. If they are more upbeat on prospects, they may invest more than £7. This is known as being ‘overweight’ HSBC.
Many academics will happily argue for days on end about which approach is best. By definition passive funds will return the average of any market. Not better, not worse. Some active funds will do better – and others will underperform and charge you for the privilege.
We have built MyInvestments using passive funds to keep our charges as low as possible and minimize the complexity of our products and range.