If you are buying an investment fund, there are two main strategies you’ll encounter – active management and passive management. Passive investing is essentially the replication of an index or benchmark. For example, buying the NIFTYBEES ETF that replicates the Nifty 50 index. The aim of active investing is to deliver returns that are superior to the stock market that the companies sit within. An actively managed fund can offer you the potential for much higher returns than what a particular market is already providing. The debate as to which of these strategies is better has been raging on for the better part of the last 20 years. Whenever stock-market indices recover from a crash, the debate re-emerges.
The problem with passive investment is that passive management is only theoretically possible.
any evaluation of passive investment funds to be complete should include withdrawal activity during draw-downs, something that can be viewed as active management by the part of the investor imposed on the passive fund.
Also, most funds that call themselves “active” are actually “passive.”
the representation of closet index funds and traditional index funds have risen to the point where they now represent approximately 40% of the active universe—making the exercise of differentiating them from true active managers more important than ever.
Traditional passive investing, using indices weighted according to market capitalisation, works best in the kind of long bull markets that ignore fundamentals, because at the end of the day, you effectively end up buying high and selling low.
Investors should be careful of simplistic arguments and biased data while allocating capital. While I remain a fan of ETFs to get broad-market exposure, it is by no means the be-all-end-all of investment choices.
Sources:
Passive Investing in Stock Indices Involves Substantial Risks
Re-thinking the Active vs. Passive Debate
