Active versus passive investment strategies in the spotlight

By Newsdesk

March 05 2024
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The latest SPIVA Australia Year-End Report has put the spotlight on the ongoing debate between active and passive investment strategies, with findings that reinforce the argument for incorporating index funds into the core of investment portfolios.

Active versus passive investment strategies in the spotlight

Duncan Burns, Vanguard's Asia-Pacific Chief Investment Officer, has commented on the data, highlighting the challenges faced by active fund managers in outperforming their passive benchmarks.

Burns noted that the report's results could be summed up succinctly: "Most active managers underperform their passive benchmarks most of the time." This statement is backed by the report's one-year underperformance figures for active Australian equity and international equity funds, which are near their highest in recent years. The findings become even more stark over the long term, with 85% of active Australian equity funds and approximately 94% of active international equity funds underperforming their benchmarks over a 15-year period.

Despite these figures, Burns acknowledged that it is not impossible for active fund managers to outperform the market. He pointed out that a number of exceptional active managers do achieve this feat. Moreover, active bond managers have shown particularly good performance over the last 12 months, although, over a three-year period, the majority have underperformed.

One of the significant challenges to active fund performance, according to Burns, is the higher costs associated with active management. These costs create a headwind that can make it difficult for active funds to outperform their less expensive, passive counterparts.

Another obstacle highlighted by Burns is the skewness of equity market returns. He explained that investors with a diversified index portfolio might experience small losses from the majority of securities but can gain significantly from a few holdings. For example, approximately 33% of the top 300 companies outperformed the S&P/ASX 300 Index in 2022, indicating that active investors would have needed to be concentrated in those outperforming companies to beat the market.

Burns concluded by emphasizing the importance of index funds and exchange-traded funds (ETFs) as a significant component of a core investment portfolio. He stated, "History has shown that investors with a majority active managed investment strategy are more likely to experience portfolio return outcomes in the larger part of the distribution that underperforms, rather than the smaller percentage that outperforms." This, according to Burns, is a driving factor behind the increasing adoption of index funds in Australian investment strategies.

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