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Active Managed Funds Versus Passive Funds

Discussion in 'Managed Funds & Index Funds' started by Johny_come_lately, 12th Feb, 2010.

  1. Johny_come_lately

    Johny_come_lately Well-Known Member

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    An Active Managed Fund is a pool of money from investors that is controlled by a fund manager. This manager then uses his skill/resources/research to beat the market. A fee is charged for this experience.

    A Passive Fund is a pool of money from investors that is controlled mostly by a computer. The computer follows a market Index. The aim is to 100% match the index, with great care to avoid a "tracking error". A small fee is charged for this service.

    Which is better? Passive is cheaper, but only gets you the market. Active offers you the chance to beat the market.

    I have a theory that, passive needs active to survive.

    What are the reasons (and examples) where one fund is better than the other? What would make you swap?




    Cheers, Johny.
     
    Last edited by a moderator: 12th Feb, 2010
  2. Waimate01

    Waimate01 Well-Known Member

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    A couple of observations come to mind:

    - On average, most investors perform about average

    - Most actively managed funds tend not to beat the index in any sort of repetitive way

    - Research has shown that, as an investor, a more frequent transaction rate does not correlate to a higher return, indeed it is more frequently the reverse. This is one reason why women tend to be better investors than men. Ever driven along near someone who's constantly switching lanes everytime there's a space? (Different matter if there's a truck broken down in your lane, of course)

    - Humans tend to over-estimate their abilities (eg, most people will estimate they are an above average driver). Even worse, the Dunning–Kruger effect shows that people who are 'bad' at something will most greatly over-estimate their ability (and people who are 'good' at something will tend to under-estimate). So most people think they can be better than average investors, and most will be wrong.

    - Taking managed funds as a consolidated group, they tend to under-perform the index by about 1% (which coincidentally is about the size of their management fee)

    So in many respects 'yes', passive needs active to survive because they are all in the same market and every buyer needs a seller.

    You could probably divide the population of investors into three sub-populations

    - successful traders: doing above average
    - unsuccessful traders: doing below average
    - buy & hold passive index investors: doing average

    It's tempting to think the first two groups balance off against each other and the third group is segregated in some way. But of course they're all playing in the same pigpen, and they all interact. The passive guys would not do as well as they do if not for the unsuccessful traders.

    It's worthwhile noting that Warren Buffet recommends most people will do best if they follow a passive approach. Same way most people will make more money being a plumber or an accountant, not a professional golfer. Yes, there are plenty of examples of professional golfers making lots of money, but if you're looking for the reliable way of getting the house, the boat and the car, for most people they're best off doing something other than golf.

    And I say this as an average investor who doesn't play golf (but IS a better than average driver! :D;)
     
  3. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    There's no reason you have to use exclusively one strategy or another.

    There is a concept called a core-satellite approach which sees a core of low cost passively-managed (index) funds surrounded by a number of smaller actively managed satellite funds which are carefully selected with the goal of increased performance.

    The key is to get a balance between the passive and the active parts of the portfolio - and how much you allocate to each part depends on your own situation and strategy.

    For example, you might have 60% in low cost index funds and 40% spread across a number of actively managed funds, or 70/30, or some other percentage.
     
  4. Johny_come_lately

    Johny_come_lately Well-Known Member

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