Active or Passive: Which is better?

Nov 26, 2020

In 2009, BlackRock acquired Barclays Global Investors, including its iShares business. That not only made it the world's largest asset manager, but it brought alpha and index strategies under one roof.

BlackRock CEO Larry Fink commented in an interaction, that most people believed it was a bad transaction, providing active and passive within the same organization. He disagreed and believed that BlackRock should offer products agnostically.

The debate over whether investors should use active or passive strategies in their portfolios has traditionally been viewed through the lens of outperforming a benchmark. This debate is misleading, because both can co-exist in a portfolio where an investor can follow a blended approach.

Active investors are simultaneously embracing passive investing. As Fink pointed out to Morningstar recently, it is a myth that everyone who is investing in an exchange traded fund, or ETF, is a passive investor. More and more active investors use ETFs to actively navigate their exposures to certain concentrations. They go in and out of active exposures by using a passive instrument such as an ETF.

In March 2015, Morgan Stanley Wealth Management introduced an Active-Passive Framework, based on the premise that each market environment and each asset class present unique circumstances for active-passive decisions. A few years ago, Lisa Shalett, CIO at Morgan Stanley Wealth Management, explained that at some periods, market opportunities are primarily about the overall market, in effect, passive index funds. Other times, the best money opportunities are in individual stocks—this is when active management adds the most value. You can read her views here as well as the results of their testing a portfolio with both strategies. A more recent update is available in the April 2020 report: Active-Passive Framework 2.0: Sharpening Its Objectives and Streamlining Its Recommendations.

The best of both worlds

At Morningstar, we believe that asset allocation is one of the most important decisions that you make as an investor. Having the right mix of stocks, bonds, cash, and commodities in your portfolio, and being well diversified within each asset class, can have a profound impact on your returns.

ETFs can be an easy way to gain this diversification.

You could have a broad-market ETF that tracks a large-cap index as a core holding, or an ETF (such as one that gives you international exposure) as a satellite holding.

In fact, Fink also commented that a big transformation was happening in fixed income, and the fixed income market is going to be substantially more of an ETF market. Actively investing one’s bond portfolio through ETFs will be a core foundation of how investors approach the debt market.

Another important role that ETFs can play in your portfolio is to provide access to alternative asset classes like commodities and currencies. ESG too is being offered via ETFs.

In India, the options are still limited. Investment Analyst Mohasin Athanikar shares his views: “Currently in India, only domestic equities have index funds or ETFs representing different market segments (large/mid/small caps) as well as the broader market. Passive international equity exposure is offered by a handful of funds, which are entirely U.S. focused. There are a few India domiciled passive funds offering fixed-income exposure in India, such as Liquid ETFs, 10-year gilt ETFs, and the Bharat Bond ETF which invest primarily into AAA-rated PSU entities and G-secs and have a run-down maturity restricting investors from selecting a target duration.”

Mohasin tells you more on that front as he guides an investor on how to have a portfolio that has a passive and active exposure.

ETFs listed on the National Stock Exchange, or NSE.

ETFs listed on the Bombay Stock Exchange, or BSE.

It’s up to you

Active or Passive: Which is better? The answer will depend on who you ask.

Neither approach is superior. Instead, the optimal combination completely depends on your financial situation and preference. Be open to allocating to active and passive strategies opportunistically. It does not serve you to view one to the exclusion of the other.

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