Investment strategy: active, passive or both?

As passive funds start to become more popular, Nick Scarrett, head of savings and investment, revisits the long running debate on which is the better investment choice - actively managed or passive funds:

"The debate over the relative merits of active and passive investment will probably always be with us, but despite the fact there is no definitive answer as to which is the better investment choice, more money is still invested in actively managed funds.

"This is probably due to their potential to outperform the market. After all, why would you settle for a market return when you could achieve much higher returns?

"But, although the potential for much higher returns is there, evidence that actively managed funds can consistently outperform the market is hard to find, and advocates of passive investment would argue that it is impossible to do so, except as a result of inside information or luck.

"And, as the global financial crisis exposed the vulnerability of active fund managers, many of whom underperformed the wider market, investors have started to look for lower costs and passive funds like Exchange Traded Funds (ETFs), which have started to increase in popularity.

"ETFs are investment funds traded on a stock exchange, much like stocks. They track specific indices, such as the FTSE 100 or S&P 500, or a sector index such as Global Health and Pharmacy or commodity index, so can give investors direct access to markets and commodities that may otherwise be inaccessible. And, like other passive funds, the costs for ETFs are generally lower than their actively managed counterparts, which charge more because of the cost of more frequent trading and research.

"So, where active funds have the potential for a higher return and more flexibility - they have to consistently outperform the benchmark to justify their higher charges - passive funds cost less, which can often mean better returns for the investor.

"One way to utilise both methods of investing is to use passive funds as your core portfolio holding and actively managed funds as ‘satellite' holdings to attempt to outperform the benchmark. The Fair Investment portfolios use a blend of active and passive funds to achieve their aims and keep overall costs down. "