Brexit or Brussels? Craft beer or Gin and Tonic? Active or passive investing? All hot topics of debate up and down the land (ok the last one probably isn’t, but it should be!).

Whether you use an active or passive investment approach when managing your portfolio can be a crucial factor which may determine long-term investment performance. So which is better, and how do we decide which approach to take when helping to manage our clients’ portfolios at Mearns & Company?

What is active and passive investing?

Let’s start by defining what we mean by active and passive investing. Active investing, as the name suggests, is the active selection of investments (whether that be funds, shares or bonds) which an individual (often a professional fund manager) believes will outperform in the future. Active investors believe that it is possible to beat the market by selecting investments with good growth prospects and avoiding investments which they think will underperform.

Passive investors, on the other hand, believe that it’s not possible to outperform the market with this selective approach. They prefer to take a more hands-off approach, often using lower-cost products to track the market as a whole.

Advantages and disadvantages

Much has been written about the advantages and disadvantages of both approaches, and I could talk for hours on the subject (ask my wife!) but, as we are all busy people (kids to taxi, box-sets to catch up on etc), I have set out the key factors we believe are most important here at Mearns & Company. This is by no means an exhaustive list:

Active investing

Advantages

• Opportunity to outperform the market
• Risk management – ability to avoid certain sectors or investments if they are deemed too risky
• Forward looking – ability to invest in tomorrow’s winners

Disadvantages

• Active investing can be higher cost
• It requires a lot more investment research
• Market outperformance is not guaranteed

Passive investing

Advantages

• Lower cost
• Very transparent – investors always know which investments are held
• Simplicity – investors can remove and reinvest with relative ease

Disadvantages

• No downside protection
• Backward focused – investments are only held once they are included in an index
• No potential to outperform the market

Mearns & Company’s approach

So, armed with a list of advantages and disadvantages for both active and passive investing, which approach do we prefer to use when managing our clients’ portfolios here at Mearns & Company? The short answer is ‘both’.

The majority of our clients’ portfolios are invested in active funds. They always have been. The extensive research that we have carried out, and the years of experience we have in this area, have always pointed to the fact that identifying outstanding funds, that consistently outperform the market over the long-term, is beneficial for our clients’ portfolios. This is something we have been successful at over the years, and the experience and diligence of our in-house Investment Committee makes me see no reason why this should change in the future.

However, it is very important to point out that we are not wedded to an active approach (or any other approach for that matter). If the weight of evidence starts to change our view, and we think passive investing is the way forward, then we are nimble enough to reassess the situation and do what we always do – recommend the most appropriate strategy to best suit our clients’ needs and help them achieve their goals.

So where does passive investing play a role in our approach? Well, some investment universes are so small, and the competitive advantages that can be found by an active investment approach are so limited, that we prefer to use passive funds. Most notably, we prefer passively managed funds in some of our lower-risk portfolios to gain exposure to UK Government Bonds (Gilts). Paying a higher fee for active fund management in this particular sector would not represent good value.

So, the next time your doctor asks you if you are staying active, remember to tell him ‘I am at the moment Doc, but only while it’s still good for my wealth!’

Written by Kevin Collie DipPFS