Active vs Passive: the blindfolded monkey debate

I am terrible at darts, so in a game of darts I can say with a high degree of certainty that a blindfolded monkey would give me a good thrashing. But is there any merit in the statement that a completely random approach to stock picking would deliver a better outcome than an analyst poring over company reports?

Inconveniently, there is an element of truth in Malkiel’s controversial comment. A 2016 study by S&P Dow Jones Indices showed that about 90 percent of active stock managers failed to beat their index targets over the previous one-year, five-year and 10-year periods; a key driver of the underperformance was their fees.

Passive strategies on the other hand, being low cost, have performed very well. Unsurprisingly, they have gained popularity and viewed by some as the paragon investment solution, with £158bn invested in passive UK retail funds (that excludes ETFs). What is even more astonishing than the size of the market is the 21% annual growth rate experienced since 2013. And fund houses and discretionary fund managers have been only too happy to ride that wave of cash with the market now awash with passive solutions.

Post 2008 Global Financial Crisis: A Goldilocks Period for Passive Strategies?

It is important to understand why passive strategies have performed so well in recent years. Since the Global Financial Crisis, the G4 central banks pumped $12 trillion into global markets; quadrupling their balance sheets.

This extraordinary stimulus has artificially boosted all asset prices, for both good and bad companies, creating the perfect environment for passive strategies to thrive. In contrast this has been a difficult environment for active management, which requires market participants to act on fundamentals rather than being influenced by the sugar rush of liquidity. However, with the gradual withdrawal of ultra-loose monetary policy market conditions will become more volatile and challenging. As a result, there will be more dispersion between winners and losers again, presenting a more fertile environment for active management to have the potential to deliver outperformance.

Blending Passive and Active Strategies for the Best Outcome

We believe that relying wholly on either active or passive strategies is unlikely to deliver the best outcome for clients, which is why we think carefully about how we build funds.

For example, we prefer to take a passive approach when allocating to US equity. The market is highly informationally efficient and liquid, making it incredibly difficult for active fund managers to beat the market.

With corporate bonds, however, we prefer to be active. Credit is a difficult asset class to track passively. Moreover, a feature of being passive means that you get more exposure to the most indebted companies.

The active versus passive debate is usually couched as binary. However, they are not mutually exclusive. Rather than being beholden to just one type of strategy, a blended approach makes sense. And back to that blindfolded monkey: rather than just splitting active and passive management thoughtlessly down the middle, investors should be pragmatic and think carefully about where they feel each can add value.

Key Risks

The value of an investment and any income from it can go down as well as up and can fluctuate in response to changes in currency exchange rates. Investors may not get back the original amount invested.

For further information on our Multi-asset funds contact your usual sales representative or our investment sales team.

IMPORTANT INFORMATION: Unless stated otherwise, any sources and opinions expressed are those of Aviva Investors as at 31 August 2018 and are not investment recommendations or advice of any nature.

Issued by Aviva Investors UK Fund Services Limited, the Authorised Fund Manager. Registered in England No 1973412. Authorised and regulated by the Financial Conduct Authority. Firm Reference No 119310. Registered address: St Helen’s, 1 Undershaft, London, EC3P 3DQ. An Aviva company.

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