Cash clinic: Passive and active investing – which is the best for me?
A recent money article in The Scotsman mentioned the importance of asset allocation and talked about passive and active investing. Can you tell me more about asset allocation? If I invest in funds should I be in the passive or active camp?”
Answer: Asset allocation is based on the idea that different assets perform differently in different market conditions.
The “traditional” asset types are cash, shares, company debt (corporate bonds), government debt (gilts) and property. “Alternative” asset classes include commodities (eg, gold), collectables (eg, art and wine), private equity, derivatives and foreign currency. Since the early days of the financial crisis, where all traditional asset classes moved generally in the same downwards direction, there has been more of an emphasis towards investing in alternative asset classes in an attempt to gain real diversification.
The opposite of not having a diverse asset allocation would be to invest solely in a single asset class; such as buying the shares of only one company or investing solely in buy-to-let properties. The risk is that because you hold only one asset type, any losses cannot be offset by increased returns from other asset classes.
An asset allocation strategy should be carefully arranged and take account of your attitude towards risk, current circumstances, objectives, time frames and the differing tax wrappers available. An amount of your portfolio will be allocated to each of the asset types in light of the above factors and reviewed each year to take account of any changes to your circumstances.
Whether or not changes are made to your portfolio as a result of market conditions and performance of the various asset types, rather than just changes to your circumstances, will depend largely upon your, or your investment managers’, views on passive and active investment management.
The passive camp argue that tweaks to your portfolio that are made simply to try and achieve better performance within a specific asset class are unnecessary, will lead to extra charges and, over the longer term, a reduced performance. Active managers argue that through their own knowledge and skill they can add value to your portfolio over and above the extra charges that might be incurred.
There are a number of different approaches to asset allocation that depend largely on how confident they are that they can predict the future relationships and returns of various asset classes.
A “strategic” asset allocation approach is predominantly used by passive managers and aims to achieve the most desirable balance between risk and return over the longer term.
A “tactical” asset allocation seeks to actively invest in assets that the manager believes are showing the potential for superior returns. A “core and satellite approach” offers a blend of both styles; a strategic core that provides a balanced foundation for the portfolio with higher risk satellite holdings targeting possible market beating returns.
The jury is still out as to whether passive or active is better and most now agree that the best idea is to adopt a balance of the two approaches.
• Mark Thornton-Smith is a financial planner at Cornerstone Asset Management.
If you have a question you need answered, write to Jeff Salway, The Scotsman, 108 Holyrood Road, Edinburgh EH8 8AS or email: email@example.com.
The above is for general purposes only and is not tailored for individual use. It does not constitute legal, financial or investment advice on any particular matter and must not be treated as a substitute for specific advice. No action should be taken in reliance of the information given. The Scotsman Publications Ltd and Cornerstone Asset Management accept no liability on the basis of this article.
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Saturday 25 May 2013
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