Factionalism – the nemesis of reason
The recent events at Lynnmall shopping centre in West Auckland provided a stark reminder of the risks of developing a mindset which is intolerant of other points of view. Although this was an extreme example, even in our day-to-day lives, we are all too prone to revert to our own established thinking and not willing to consider other points of view. Perhaps factionalism comes pre-packed as part of the 'human condition'. My observation is that, if we succumb to this way of thinking, we limit ourselves and our opportunities.
When it comes to financial advice, there are common themes that most advisers will agree on: diversifying your capital across different asset classes and geographies, investing in accordance with your risk profile, time frame, and being mindful of tax efficiency are examples. However, the area where factionalism tends to 'rear its head' is the question of active management vs passive management.
The difference between these two styles1 can be defined as:
• Active portfolio management focuses on outperforming the market in comparison to a specific benchmark, such as the Standard & Poor's 500 Index.
• Passive portfolio management mimics the investment holdings of a particular index in order to achieve similar results.
As the names imply, active portfolio management usually involves more frequent trades than passive management. The fact that passive management involves less intellectual thought and can be accessed in a lower cost way, generally means that passive management is cheaper.
The factional debate occurs around the claims made by advocates of passive investing that active management does not generate sufficient returns to justify its costs. Each 'camp' can point to research which will support their views.
Although not explicitly stated, this active vs passive debate was evident in the recent Government review of the KiwiSaver default providers. In this review the Government signalled the replacement of four of the incumbents (AMP, ANZ, Fisher Funds and Mercer) from December 2021. These managers tended to have more active management styles. This contrasts with the two new managers, Simplicity & Smartshares (NZX), both of which promote a passive approach with the resultant lower fee.
The Government's thinking in this area might not be driven by any belief that passive management is superior to active management. It could just be their wish to see lower fees that has resulted in active managers being replaced by passive managers.
When considering the active vs passive 'divide', I have tended towards the active side. My views are based on the experience of active management being able to isolate the client from the extremes that markets periodically experience. By protecting the client from significant drawdowns (e.g. more than 30%), you see a situation where clients are much more likely to stay invested and be able to continue with their investment journey.
This is opposed to being frightened out of the market, moving into cash and converting short-term volatility into a permanent loss and then missing out on the inevitable market recovery.
However, I fully acknowledge that there are some clients who have the fortitude and discipline to stay invested during periods of extreme market volatility. For them a lower cost passive fund could be a suitable alternative.
As an adviser, I see the essence of my role as matching the investment recommendations with the client's needs and investment personality. This means that there are circumstances where a passive low-cost approach will be the most suitable solution, but for other clients the benefits of active management will warrant paying a higher fee. And yet other situations where a hybrid approach may be the ideal solution.
In this way I see the active vs passive issue not as a debate, but just one of the discussion points that form part of the client adviser conversation. An old friend once suggested to me that we should be wary of those who speak in absolutes; our choices are seldom completely black and white. For me the passive vs active debate falls into this category. Each client situation is different and diversity is a good thing.
When it comes to financial advice, there are common themes that most advisers will agree on: diversifying your capital across different asset classes and geographies, investing in accordance with your risk profile, time frame, and being mindful of tax efficiency are examples. However, the area where factionalism tends to 'rear its head' is the question of active management vs passive management.
The difference between these two styles1 can be defined as:
• Active portfolio management focuses on outperforming the market in comparison to a specific benchmark, such as the Standard & Poor's 500 Index.
• Passive portfolio management mimics the investment holdings of a particular index in order to achieve similar results.
As the names imply, active portfolio management usually involves more frequent trades than passive management. The fact that passive management involves less intellectual thought and can be accessed in a lower cost way, generally means that passive management is cheaper.
The factional debate occurs around the claims made by advocates of passive investing that active management does not generate sufficient returns to justify its costs. Each 'camp' can point to research which will support their views.
Although not explicitly stated, this active vs passive debate was evident in the recent Government review of the KiwiSaver default providers. In this review the Government signalled the replacement of four of the incumbents (AMP, ANZ, Fisher Funds and Mercer) from December 2021. These managers tended to have more active management styles. This contrasts with the two new managers, Simplicity & Smartshares (NZX), both of which promote a passive approach with the resultant lower fee.
The Government's thinking in this area might not be driven by any belief that passive management is superior to active management. It could just be their wish to see lower fees that has resulted in active managers being replaced by passive managers.
When considering the active vs passive 'divide', I have tended towards the active side. My views are based on the experience of active management being able to isolate the client from the extremes that markets periodically experience. By protecting the client from significant drawdowns (e.g. more than 30%), you see a situation where clients are much more likely to stay invested and be able to continue with their investment journey.
This is opposed to being frightened out of the market, moving into cash and converting short-term volatility into a permanent loss and then missing out on the inevitable market recovery.
However, I fully acknowledge that there are some clients who have the fortitude and discipline to stay invested during periods of extreme market volatility. For them a lower cost passive fund could be a suitable alternative.
As an adviser, I see the essence of my role as matching the investment recommendations with the client's needs and investment personality. This means that there are circumstances where a passive low-cost approach will be the most suitable solution, but for other clients the benefits of active management will warrant paying a higher fee. And yet other situations where a hybrid approach may be the ideal solution.
In this way I see the active vs passive issue not as a debate, but just one of the discussion points that form part of the client adviser conversation. An old friend once suggested to me that we should be wary of those who speak in absolutes; our choices are seldom completely black and white. For me the passive vs active debate falls into this category. Each client situation is different and diversity is a good thing.
This document has been provided for information purposes only. The content of this document is not intended as a substitute for specific professional advice on investments, financial planning or any other matter.
While the information provided in this document is stated accurately to the best of our knowledge and belief, New Zealand Funds Management Limited, its directors, employees and related parties accept no liability or responsibility for any loss, damage, claim or expense suffered or incurred by any party as a result of reliance on the information provided and opinions expressed except as required by law.
While the information provided in this document is stated accurately to the best of our knowledge and belief, New Zealand Funds Management Limited, its directors, employees and related parties accept no liability or responsibility for any loss, damage, claim or expense suffered or incurred by any party as a result of reliance on the information provided and opinions expressed except as required by law.
***
Peter Ashworth is a Principal of New Zealand Funds Management Limited and a Financial Adviser based in Dunedin. The opinions expressed in this column are his own and not necessarily those of NZ Funds. His disclosure statements are available on request and free of charge.
***
First published in the Otago Daily Times on 15 September 2021, as 'Factionalism not helpful for best investing strategy'
