How to get the best of both active and passive with an MPS

You’ve got the passive keeping the cost down and focused on those efficient markets, and the active where there’s maybe more opportunity.Anastasia Georgiou, Morningstar

When it comes to those who favour a passive approach, Lawrence at 7IM says: “[They] will either point to the fact that for some time now they’ve had the upper hand on their active cousins in terms of performance, or they will simply state the undeniable fact that it’s a much cheaper option.”

Indeed, passives can be around a quarter of the cost of actives in terms of underlying holdings, according to Jane Bransgrove, director of asset management at Charles Stanley.

The best of both

However, as well as active and passive managed portfolios, some MPS providers have a hybrid offering.

Given the cost sensitivity associated with active management, Lawrence says an increasing number are moving to the middle ground, with a hybrid solution that looks to optimise for high alpha at lower cost.

“This typically involves blending high conviction managers in regions or allocations where history has shown it is beneficial to do so, with the cheapest passives in the areas where you’re not as rewarded for the extra costs,” he says.

Clients should buy flexible investment mandates where the underlying investments are selected in the interest of the client return. Antony Webb, Quilter Cheviot

Georgiou at Morningstar also says that a blended approach enables passives to be used for more efficient markets. “

So perhaps you’d use passive for markets like the US, where it would be difficult to generate alpha, and then you would be taking an active approach potentially in markets like emerging markets, or in the small-cap space, where you can look to generate that alpha.

“So I think that’s where you get the best of both worlds. You’ve got the passive keeping the cost down and focused on those efficient markets, and the active where there’s maybe more opportunity.”

Any investment style, active or passive strategy can be wrong. Why embed inflexibility in your investment choice?Antony Webb, Quilter Cheviot

Webb at Quilter Cheviot likewise says that there are times when index exposure would benefit a client, and other times when highly active positions can add value.

“Clients should buy flexible investment mandates where the underlying investments are selected in the interest of the client return, rather than fitting an investment strategy intrinsic to the fund management company’s business model,” Webb adds.

He continues: “2022 has shown the challenge of being highly active when markets rotate due to macro factors. Most active funds are significantly behind benchmark.

"Many of them could have positions to protect clients from the rotation, if their investment process wasn’t wedded to a high conviction, long-term strategy.