Active Investments versus Passive Investments – what’s the difference and why it matters?

The debate between Active investing against Passive investing continues to prevail in the world of investments. We previously spoke about the debate first in our blog and highlighted how it is our view that both investment methods have their place in a well-diversified proposition, as such we use active and passive investment strategies in our own portfolios.

Here, we dive deeper into the debate to provide a clearer insight into the differences between the two strategies, with reasoning on why at Francis Clark Financial Planning we continue to adopt both approaches in our portfolios.

Active management is about ‘beating’ the market, whereas a passive investment strategy is more focused on ‘being’ the market.

Naturally, through its passive nature a passive investment strategy is limited in how much it can do to provide investors with a return above a stated benchmark. However, with investors becoming increasingly aware of the impact they can have on the world, many wish to see more than just returns from their finances. To meet this demand, passive investment managers are increasing their efforts to encourage positive impact within society. Whilst they are unable to apply any filtering to the types of companies the fund invests in, managers can utilise their positions as large shareholders to encourage better practices to be adopted within the companies whilst also voting at the businesses’ AGM to help take the company towards more sustainable outcomes.

At Francis Clark Financial Planning, we take a balanced view in the active vs passive debate and adopt both styles of managers in our investment strategies. For the passively managed element within our investment portfolios, we seek to work with managers who exercise a high level of engagement with the underlying businesses to ensure our clients’ money is being put to good use whilst continuing to offer a robust, diversified investment strategy.

Our active managers have a much wider remit in how they can differentiate themselves from their peers. When making investment decisions, particularly when looking at individual companies, an active manager can choose which investment ‘style’ they wish to adopt.

There are two main styles which an active manager can adopt when looking at a potential investment – to steer towards either a ‘growth’ holding or a ‘value’ holding.

Growth focused investments are more about looking forward and tend to include companies with a focus on the future and with less concern with the picture at present. Growth style businesses tend to have higher levels of borrowing and debt, with the view that it will turn to profit in the long run.

Value style investments are much more focused on the numbers. A ‘value’ orientated manager focuses (amongst various other factors) on businesses which have an attractive share price relative to the company earnings/profit. These businesses tend to have their share price trade at a lower multiple of the company earnings compared to their growth focused counterparts, hence presenting greater ‘value’ relative to a growth focused company which often trades at a much higher multiple of company earnings.

There are, of course, many other factors which go into the consideration of investment management. These include another area we ourselves pay particular attention to – sustainability. The growth versus value debate is just one of many trade-offs within the world of active management. At Francis Clark Financial Planning, in our core portfolios we aim to have a well-rounded approach with high levels of diversification across all asset classes. However, as a key theme our investment partners believe it is the high quality, growth style businesses which will be the best long-term performers going forward. High quality companies with robust business models and healthy cash flows are likely to be those which continue to succeed in many years to come.

Clearly the topic of active versus passive investing has much more to show, however the above summarises some of the key factors we and our investment partners take into consideration when building investment solutions for our clients. Our propositions continue to present a blend of engaging passive investment managers with active managers focusing on sustainability and high-quality forward-looking businesses.

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If you would like further information on our investment propositions, please get in touch with your local financial planner or contact a member of our team.