There has been a LOT of debate over the years about whether active fund managers add value, or whether you are better off investing into a low-cost alternative such as an Index Fund or Exchange Traded Fund (ETF).

The reality is not as simple or clear cut as the marketing teams from each side make it out to be. You should be very careful about what you invest into and therefore make informed decisions. Caveat Emptor is a phrase that is more important now than it usually is. In this article, we’ll look to explore why this is the case.

First, let’s revisit the main tenants put forward by each camp:

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Of course, the above summary is rather simplistic and there can be many nuances to each offering. And indeed, despite the listed pro’s and con’s each offering has its place and can be the most suitable solution for any given situation. There is no ‘right’ and ‘wrong’ in the choices we have, they are simply choices.

What does concerns me, at this particular point in time though, is that due to the success of low cost index type offerings billions of dollars have been pouring into them. This is all well and good until you realise that the more money that is buying these index funds means the more money is buying the ‘market’, thereby becoming a self-fulfilling cycle that drives the market up. This is great, until it the music stops and the money reverses. At that time the market is sold regardless of merit, with the inevitable result being the market falls.

This has the potential to create more volatility in markets than may be warranted, which has a knock-on effect of potentially hurting investors, most likely the ‘mum and dad’ investors.

The main ’problem’ I see with passive, low cost index investing this is that it’s a weight of money issue rather than a well-considered, rationale investment. Who would invest like that? It’s great if you can time markets and they’re on the way up, but it’s the downside that most worries me and the awful impact that can have on well-meaning but ultimately less informed investors. No disrespect to anyone, but most investors do not have access to the same information, in as timely a fashion as professional investors, so it’s not exactly a level playing field.

This is precisely where active managers should step up to the plate and earn their fees. Though their research a good active manager should sort out the good investments from the bad investments and, on the whole, provide a higher quality portfolio. In a market downturn, such a portfolio should fall less than the market, that is, they should help protect your capital. Ultimately, this is a very important point to consider. It’s all well and good to make great returns but it can be irrelevant if you lose it all the next day, and we all know that putting money aside to invest is not that easy in the first place. Protecting it makes sense.

As a general observation, it seems to me that as investors we’ve all become a little complacent about risk and for some reason we expect markets to go up forever. In this environment, low cost investment offerings are very attractive – and make a lot of sense. Lots of stats are quoted about how few managers add value after fees and so forth. It’s a tough gig for any active manager when money pours into markets, sometimes without merit. What can they do? Abandon disciplined investment fundamentals and follow the markets?

But we all know, or at least those of us that have been around long enough or have thought about it, that markets do not go up in a straight line. There have always been periods of significant dislocation throughout history, in every market, be it shares, property or fixed interest.  It would be more than a little naïve to think it won’t happen again. In fact, one could be forgiven for thinking that despite what the general media and markets are telling us there are very significant risks investors should consider, for example: rising geopolitical risks, likely rising interest rates around the world, excess government stimulation following the GFC creating distortions in markets and valuations of some assets, most notably Australian housing (and others) and US equity markets (and others). There are always opportunities within markets, but if you’re buying the market, as in using an index fund, then there is no hiding the fact you’re taking a lot of risk. Is it really worth the 0.X% cost savings? Food for thought, at the very least.

Now of course not every ‘active’ fund will do well and protect your capital and there are good and bad managers out there, so this is where the ‘caveat emptor’ phrase comes back into the conversation. Careful selection is warranted. Take the time to find the good managers. They are out there. We see them all the time. Find the managers that match up to what you want to achieve in your investment portfolios, that might think like you, that you can trust to look after your money. It’s worth the time and effort to think about these things. Likely less effort than it would be to replace any lost capital anyway. Alternatively, find someone that can help you match up good investments with what you want to achieve. It’s your money. How actively do you want it looked after?

For more information about Active investing please contact your adviser at WLM Financial Services.