Both active and passive strategies have a role to play in portfolios, but it is important for advisors to help their clients understand the pros and cons of each so they can make the most informed decisions about which strategies they use.
Passive is not a passing fad
Much of the interest in passive strategies stems from an increasing focus on cost above other investment considerations. As they provide clients with a complete accounting of the costs associated with various strategies, advisors can also work to ensure that clients are not mistakenly assigning benefits to index funds that they do not actually provide, including protection from any potential losses that can be incurred in a down market. Clients should be aware that passive strategies, by definition, follow the market in either direction – both up and down.
Putting risk first
Whether a client is saving for college tuition, building a retirement plan, or legacy planning, risk should be one of the first considerations when helping clients build portfolios. According to the 2016 Global Survey of Financial Advisors, two-thirds of advisors worldwide believe investors have a false sense of security about passive investments. About the same number of advisors report investors are unaware of the risks associated with passive investments – that they are committed to following the market down. While passive strategies present the potential for lower risk, often at a low cost, they typically have no inherent risk management. Nearly three in four (71%) advisors worldwide say investors are unaware passive strategies expose them to the same headline risks – environmental, social, and governance factors – that active strategies face.1 By overlooking risk management, investors may be ignoring a range of factors – and other investment strategies – that could aid them in building a more balanced, goal-oriented portfolio.
Knowing Active When You See It
Many criticisms of active strategies have been borne out by the actions of the investment industry itself. Practices such as closet indexing, launching trendy products, and missing the primary importance of the investor’s financial goals have harmed the overall reputation and average performance of many active managers. Four in ten advisors (41%) say they use passive investments because there are so many active managers who are really “closet indexing” – or constructing portfolios that are similar to an index without exactly replicating that index.2 By contrast, true active managers have the ability to position their portfolios defensively to help mitigate losses. A truly active fund will often have high Active Share, which creates strong potential to generate alpha – or returns in excess of the benchmark.
Advisor as Informed Advocate
Today’s financial advisors have an opportunity to serve as informed advocates to their clients, ensuring that they utilize authentic investment strategies in pursuit of their unique financial goals. Natixis Global Asset Management seeks to help financial advisors meet this opportunity by providing a consultative, insight-driven partnership. We believe Durable Portfolio Construction® – our signature, risk-minded investing approach – can help advisors and investors make informed long-term investment decisions regardless of market gyrations. An overview of the fundamental principles of this approach can be viewed here. To access timely, actionable market insights and information on global investor sentiment, stay up to date with the Durable Portfolio Construction® Research Center.
1 Natixis Global Asset Management 2016 Global Survey of Financial Advisors, CoreData Research, July 2016. 71% of advisors believe investors do not realize that index funds leave them exposed to headline risks such as environmental, social, and governance factors. Actively managed strategies may also expose investors to possible headline risks.
2 Natixis Global Asset Management 2016 Global Survey of Financial Advisors, CoreData Research, July 2016.
Active Share: Active share indicates the proportion of portfolio's holdings that are different than the benchmark. A higher active share indicates a larger difference between the benchmark and the portfolio.
Alpha: A measure of the difference between a portfolio's actual returns and its expected performance, given its level of systematic market risk. A positive alpha indicates outperformance and negative alpha indicates underperformance relative to the portfolio's level of systematic risk.
Active Management: Active management (also called active investing) refers to a portfolio management strategy where the manager makes specific investments with the goal of outperforming an investment benchmark index.
Passive Management: Passive management (also called passive investing) is an investing strategy that tracks a market-weighted index or portfolio.
Durable Portfolio Construction® does not guarantee a profit or protect against a loss.
This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.
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