Why this might be the best time in years to invest offshore
30 August 2021
The debate regarding active and passive investing has been going on for decades with it being the most debated and researched topic in the investment industry. Regardless of this, the topic has in recent years received renewed attention with various investors from each side of the equation putting forward arguments and statistics to support their differing views.
So why has this topic received so much renewed attention lately? The answer is simple; There has been wide-spread under-performance by active mangers since the economic crises in 2008. Statistics show that 75%-85% of all active managers in the United States under-perform their respective benchmarks after fees.
These statistics are highlighted by the below graphics which illustrates this under-performance in both America and Europe respectively over a 5-year period ending December 2018.
Source: SPIVA on Indexology (2018) The underperformance is the reason that more and more money is flowing from the active investment strategy towards a more passive style of management. This trend is confirmed by the below graphic which illustrates the exodus of funds away from active US equity towards passive US equity.
A passive investment strategy is advantageous in that it has ultra-low fees. The low fees stem from the fact that there’s nobody picking stocks, so oversight is much less expensive. Passive funds simply follow the index they use as their benchmark. A further advantage of passive investment is the degree of transparency found within this strategy. With passive investments, it is always clear which assets are in an index fund. The use of a passive investment strategy also results in improved tax efficiency as the buy-and-hold strategy employed doesn’t typically result in a massive capital gains tax for the year.
The advantages of employing an active investment strategy include a slightly extra degree of flexibility as active managers are not required to follow a specific index. Active managers also have various techniques at their disposal such as short sales or put options. Managers that use this strategy are also able to exit specific stocks or sectors when the risks become too large.
The shortcomings of active investing are apparent as this type of strategy can be expensive with the average expense ratio of actively managed equity funds sitting at 1.40%. This is compared to the average expense ratio of passive equity funds which sits at 0.60%. The higher fee structure is as a result of increased expenses such as transaction costs. These additional fees end up accumulating over the investment period thus dampening investment returns.
Active investing, as its name implies, takes a hands-on approach and requires someone to play the role of a portfolio manager. The goal of active money management is to beat the stock market’s average returns and take full advantage of short-term price fluctuations. It involves a much deeper analysis and the expertise to know when to pivot into or out of a particular stock, bond, or any asset.
If you’re a passive investor, you invest for the long haul. Passive investors limit the amount of buying and selling within their portfolios, making this a very cost-effective way to invest. The strategy requires a buy-and-hold mentality. That means resisting the temptation to react or anticipate the stock market’s every next move.
Involves taking advantage of profitable conditions in the market in an attempt to “beat the market”.
Transaction frequency is at a much higher rate with the occurrence of high levels of buying and selling.
Lower operating costs with the additional advantage of improved tax efficiency.
Ignores short-term fluctuations and focuses on the long-term.
More concentrated portfolios combined with fewer securities than a broad market index.
More concentrated portfolios combined with fewer securities than a broad market index.
Low flexibility, the strategy involves buying and selling based on changes in index composition, suffers from market volatility due to limited use of strategies.
SPIVA on Indexology. (2018). SPIVA® Statistics & Reports. Retrieved 30 July, 2019, from https://us.spindices.com/spiva/#/reports
Strauts, T. (2018). 5 Charts on US Fund Flows That Show the Shift to Passive Investing . Retrieved 30 July, 2019, from https://www.morningstar.com/blog/2018/03/12/fund-flows-charts.html
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