Both have their own advantages to offer, passives are inexpensive, follow the market and offer good diversification, while actives tap into manager abilities to stock pick and time the markets, both of which can generate alpha.
But are multi-asset funds missing out on a relatively new phenomenon, a phenomenon which seems to be gaining traction within the investment community?
This new style is dubbed smart beta, also known as alternative indexing and supporters claim that these indexes provide superior returns, often with fewer amounts of risks.
But do supporters really have a firm ground to support their claim about this new style?
The idea of smart beta is not new; it has been around for the past 10 years when the S&P first introduced its first equal weighted index back in 2003. However, we are now bombarded with terms such as low volatility indexes; value tilted indexes, fundamentally weighted indexes, indeed, if there is a way to screen stocks, there can be an index created around it. The basic idea focuses on the idea that market cap weighted indexes are flawed.
Currently many passive funds rely heavily on market cap weighted indexes such as the FTSE 100 or S&P 500. Indexes such as these represent a huge proportion of the total passive market and when these indexes are constructed the market capitalisation of the companies are used. So in the case of the FTSE 100, it consists of the 100 most valuable companies in the UK all-share market.
These valuable companies are designated so according to their market share price multiplied by amount of shares available in the market (total market capitalisation). So for a company such as BP that has a current market price of 493p (as of 8 January) and shares outstanding of 18.59bn, this equates to a market cap of £91.75bn. In BP’s case relative to its peers, it has a high market value and would therefore receive a high weight in the FTSE 100 index. And for a company such as Bunzl that has a share price of approximately 1423p (as of 8 January) and shares outstanding of 333.48m, its market cap is roughly £4.73bn, so would receive a lower weight in the index respectively.
Supporters believe that markets can incorrectly price companies, thus believing that the is flawed