The first decision they face is deciding which investment strategy they want to follow. In general, in the investing world there are two completely different philosophies that are very close to each other: the active management strategy and the passive management strategy.
In this article we will write down each of them, analyzing their pros and cons. In addition, we will present a third way that is becoming increasingly relevant: actively choose in which indices to invest and subsequently adopt a passive strategy.
Active management vs passive management, how are they different?
The active management It is the classic investment strategy, which has always made the headlines of the press and the most popular in the investment world. Until very recently, it was practically the only option in the fund industry.
In her, the fund manager selects the assets that make up the investment portfolio. Based on your opinion and the information you have available, choose those assets that you think will behave better in the future. The objective is to exceed the average profitability of the market.
In the passive managementMeanwhile, the fund manager plays a more irrelevant role. Your opinion and your analysis of the market situation lack the slightest importance when selecting the assets that will form the investment portfolio.
The only passive management you are looking for is replicate a stock index. This becomes the reference to follow and the investment strategy is to copy its composition and behavior. No more
With an example you will understand better. Think of an index like S&P 500, formed by the 500 most important companies in the United States. This is its historical evolution:
An indexed investment fund, which is a passive management fund, would replicate the index, that is, it would buy shares of the 500 companies that form it and in exactly the same proportion. His goal would be to achieve the same profitability as him. No more, but not less.
An active management fund, meanwhile, would only invest in index companies which, in the opinion of the fund manager, will be the most profitable in the coming years. Its objective would be to achieve a higher return than the index.
Examples of active funds there are thousands. Some profitable in recent years are Gesconsult Renta Variable, Eurizon Fund-equity Italy Smart Volatility and Esfera / Robotics. Among the passive management funds, the most prestigious are those marketed by Vanguard, the Amundi and the Pictet.
Which investment strategy is better?
Warren Buffet is the most famous investor in the world. The investment strategy that follows is active: he and his team select the companies in which to invest, and to have the data, they do not do anything wrong.
But nevertheless, Buffet is an advocate of passive management. So much so that in his will he has said that his inheritance must be invested 90% in a fund indexed to the S&P 500 with low costs and the remaining 10% in US short-term bonds. It is how much less curious.
Even bet a million dollars that stock indexes were able to beat the best active management investment funds in the market. The fund manager Protege Partners LLC accepted the challenge, and lost it.
On a more earthly level, we must start from the basis that neither you nor I are Warren Buffet. We neither have their knowledge nor do we have their tentacles. We are normal, mediocre investors with no real ability to make predictions based on data.
And conventional investors like you and me are only interested in two things when selecting an investment fund: its profitability and its commissions, factors that are also closely related.
Well, there are two facts that speak for themselves and that I would like you to understand:
1. The commissions of active management funds are much higher than those of passive management funds.
While we can contract an indexed Vanguard or Amundi fund (liability) paying around 0.3% in commissions, any active fund marketed by the bank has total expenses that can be around 3.40%. It is a brutal difference with a huge impact on profitability.
2. Most active fund managers fail to beat the market consistently in the long term.
There are numerous studies in this regard, for example, a well-known one from Spiva from which it follows that in 10 and 15 years more than 80% of active funds achieve a lower return than the market.
Another recent study by Finizens, one of the main robo advisors in Spain, concluded that for a time horizon of ten years, Passive management has generated a return of up to 76.1% above active management.
What investment style is most successful?
Despite the demonstrated superiority of passive management, at present, in Spain it barely represents 2% of the total investment, while in Europe this representation reaches 19% and in the United States 33%.
In the following image, taken from the same Finizens study, you can see how the market shares of both investment styles have evolved in the last decade.
Taking into account that these passive funds are easier to hire and manage, cheaper and also achieve greater long-term profitability, everything suggests that The growth potential of this investment style is enormous. In fact, the market share data of each management style already supports our theory.
In this other graph you can see the annual growth rate of the volume of assets treasured by passive management and active management in the period between 2008 and 2018.
Only in terms of volume of assets managed, passive management has grown 4.7 times faster than active management in the last decade.
However, the passive strategy also has some cons. The most important is you have to know how to correctly choose the index in which to invest.
This is precisely the strength of the third way that we present to you: an expert manager chooses the indexes correctly (it is his active part), but without the costs involved in traditional active management (analyst team, portfolio turnover , etc).
An example, Baelo Patrimonio
Baelo Patrimonio is a Author fund managed by Antonio R. Rico, a well-known blogger of the investment world. He is the creator of the blog InversorInteligente.net and, after years explaining his ideas on the internet, he set out to create a fund with which to open his theories to more participants.
The Esfera I Baelo Patrimonio fund went on the market in March 2018 and in just a year and a half of life manages a wealth of almost 30 million euros. Its more than 2,000 participants are more than that: unconditional fans of the fund and its manager are declared.
Although the management of this fund is very passive, it is not one hundred percent. Antonio makes a previous selection of the indexes and groups of actions that are part of it. In other words, the assets that compose it are chosen manually by him, but once selected, the turnover of the portfolio is minimal, so the fund puts the focus on the long term and adopts a passive management strategy.
The objective Baelo Patrimonio is achieve moderate long-term profitability and, for the moment, he is fulfilling it.
A few weeks ago we had the opportunity to speak personally with its founder about his investment philosophy.
Antonio is not an investment fund manager to use, but a simple and close person. I asked him to explain to the readers of El Blog Salmon what Baelo Patrimonio is:
Baelo is a mixed equity fund, of moderate risk due to volatility, not indexed but passively managed, and that draws on the investment philosophy of mentors such as John Bogle, Harry Browne and William Bernstein, with a dividend growth bias to the equity part.
The dividend growers, or dividend aristocrats, form a very important part in the composition of the Baelo equity portfolio, and are responsible for this fund having, in theory, a great ability to overcome economic crises without suffering excessive volatility.
Dividend growers have been beating the general market for 40 years, also beating it in each of the 4 natural decades. Its growing dividend is a consequence of common characteristics such as stability in the growth of benefits, being financed prudently, content payout to continue growing and investing capital, high margins, competitive advantages in its products and services …
All these concepts mean that they also have a quality factor, which makes them less volatile and more prized by investors in their constant fear of bad stock cycles.
Although Antonio Rico is an advocate of passive management, in the war between professional managers and indexes, Baelo is positioned in an intermediate position, although winking passive management. This has an explanation, in the words of its manager:
Nothing is 100% passive, but there are more and less passive strategies. The more passive, less costs, lower turnover of assets, less errors due to speculative decisions, less taxes paid … There is no science to show that active management is capable of beating the market for reasons related to having a special skill or talent, so it is not worth bearing the burden of costs and mistakes you can make when you are too active.
It is possible that the success of this fund, which last year won the Rankia award for best fund in its category, is precisely due to letting do and not intervene more than necessary. Not surprisingly, it is the fund with the lowest asset turnover in the market (0%) and the lowest brokerage costs that it could find (0.016%).
Trust in managers
Definitely, Active management is based on the confidence that a manager will do better than the market steadily, and you will have to do much better so that management costs (much higher) do not eat profitability.
With passive management there is no such problem: costs are minimal and long-term profitability is safer. However, it must be the investor who decides the index in which to invest. Although this is not really difficult, for someone who is approaching the markets for the first time may have its complication.
With cases like Baelo's, again, you have to trust the manager to do it right. The profitability of our investment depends, to a large extent, on it. However, the costs are much lower, almost at the level of passive management, and this has a direct impact on the fund's performance.