Active vs passive: In search of the perfect blend

Combining a core of passively managed tracker funds with a selection of actively managed alternatives can help add balance to a portfolio. Active fund managers are generally free to select the investments they believe will perform best. They could choose those they believe will perform strongly in a rising market, or those they believe will offer some relative protection if markets fall.

In return for giving up some of the certainty over how their investment might perform, investors could achieve significantly better returns than those available from the index. This will come at a higher cost than simply tracking the index, but many investors do not mind paying a little extra for an actively managed fund where the manager has demonstrated an ability to consistently add value.

Actively managed funds are prone to periods of underperformance and some of the best managers go through periods where their style is out of favour

The issue for many is that too few fund managers have shown an ability to consistently add value for their investors over the long term. Finding a good active manager involves a great deal of research. Some of the best have a number of things in common, including:

- A long, measurable track record

- Consistent approach

- High conviction stock picking

- A willingness to stand apart from the crowd.

The disparity in performance between funds highlights how important manager selection is. Over the past five years, the best performing actively managed UK fund has grown by 140 per cent, but the worst is down by 44 per cent. The disparity in performance between UK tracker funds is much narrower. As most investors will appreciate, to achieve greater rewards, often more risk must be taken.

Crucially, a long-term investment horizon is also essential. Actively managed funds are prone to periods of underperformance and some of the best fund managers go through long periods where their style is out of favour. Managers with a more defensive approach and a focus on capital preservation often fall out of favour during a strong bull market as investors pile into more aggressively managed funds at the top of the performance tables.

Unfortunately, this means they miss out on the benefits of owning such funds when markets fall. By the time they appreciate the benefits of such an approach, markets are often recovering and the aggressive funds are performing well again.

For most investors simply holding a good mix of funds for the long term is probably the best approach. Core exposure to key markets can be gained via cost-effective passive funds, which can be combined with various active strategies to help achieve desired long-term outcomes.