Ordinary investors have long debated the advantages of actively managed funds, versus a passive management portfolio.

Those in favour of passive investing, also known as ‘indexing’, believe that the optimal results will be achieved by matching the performance of chosen market indexes—and holding them for the long-term. The pundits of passive portfolio management often laud the low fees, transparency and tax efficiency.

Those in favour of active investing believe that the active manager—whose goal it is to outperform the market—provides the most benefits for investors. Active management means that professionals look after the investor’s portfolio and frequently make decisions on whether to buy, hold or sell assets.

When deciding between an active or passive portfolio, many considerations should come into play—including but not limited to, the investor’s personal goals and timeline, risk assessment, tax and cash flow considerations, amongst others.

Capturing Opportunity

The greatest benefit of an actively managed portfolio is their opportunistic nature—active funds create the chance for the fund managers to generate much higher returns than the benchmark.

Active management is the “process and procedure for how we continually invest money. We [use] very mechanical, math-driven systems and don’t count on a single model,” Ken Graves, CIO of Capital Research Advisors and president of the U.S. National Association of Active Investment Managers, told CNBC.

Fundamentally, active managers also have more flexibility than passive funds to implement strategies and identify stocks that are trading at a lower price than their value. “Active management creates a situation where you can avoid damaging downturns in the market and capture the most upturns,” Graves said.

According to Morningstar data cited by CNBC, 24% of active funds outperformed their rival index funds in the decade between June 2010 and June 2020. Yet, in certain categories, active funds tended to significantly outperform their index counterparts – 63% of actively managed high-yield bond funds, 60% of global real estate funds and 54% of emerging markets funds beat their index counterparts during the same time period.

Other statistics cite more impressive performances from actively managed funds. Investopedia, citing the 2017 Wilshire Associates Active Management Review, says that active managers who invested in large-cap value stocks were most likely to beat the index—outperforming by 1.13% on average each year. In addition, actively managed funds help investors mitigate risk and reduce vulnerabilities in a downturn. During a downturn, fund managers can minimise losses by picking out – and staying away from – troubled firms, and avoid overconcentration in certain sectors or regions. An individual investor who passively invests is also at risk of falling prey to normal, human behaviour – panic. Many investors tend to worry during a downturn and exit the market at the worst possible time.

Though an actively managed portfolio may cost more in fees than a passively managed one, fund managers help manage the ups and downs of portfolio performance – assessing the various needs of the investor including personal goals, risk profile, timeline and cash flow.

Objectives-Based

Some investors may also have specific objectives. The growing popularity of responsible investing – i.e. investing only in companies that align with best ESG (environmental, social and governance) practices, and avoiding those who don’t – is a target that fund managers can help with. Money managers can help identify and assess the best opportunities for value among the companies which abide by ESG standards.

Attuned to the market, fund managers may also have particular expertise in certain sectors that an individual investor may want more exposure to; the portfolio manager can help the investor select the stock or group of stocks that he/she believes is undervalued in a specific sector.

Like the rise of ESG investing, many investors are looking to invest in so-called “new economy” segments like renewable energy, electric vehicle, biotechnology and other high-tech sectors like artificial intelligence and cloud computing.

For investors, a “buy-and-hold approach is not enough,” says Chloe Shea, associate investment director, multi-asset at Schroders.

Fund managers can help investors build a “thematic portfolio” that can “withstand different challenges in diverse market environments by adopting a flexible and active approach in asset allocation,” she says. Thematic investing, which is not passive, means analysing economic structures, cycles and trends and “invests in the relevant industries or companies that stand to benefit from these structural shifts”.