Active or Passive investing?

Active investing on a professional basis should appeal at least in theory to investors, in that monies are entrusted to professional investment managers who supposedly have the skills and knowledge to beat the market in a very complex environment. For these professional services fees are charged, upfront and continuous. It represents a hurdle rate for investors when comparing their returns with the market, in other words the extra return generated by active investing must first cover these expenses before the magical outperformance can be attained.

Active investing is a disciplined and scientific approach and success in terms of outperformance should have a high probability, yet reality and past experience indicate otherwise. Investment performances, especially for portfolios predominantly invested in equity markets are volatile and fairly unpredictable. No professional money manager can guarantee that the returns from the investment fund would be better than the market average (index), or that the outperformance of the market will be consistent.

The advent of index investment funds internationally over the past two decades has provided investors with an alternative to active investing at much reduced fees. Various international studies in the past decade have shown that index investing outperformed the average actively managed fund and led to the widespread adoption of this strategy. In most developed capital markets around the world up to 20-30% of equity investment funds (institutional and private) are invested in index funds and are growing fast, yet in South Africa index investing is miniscule by comparison and probably well less than 5% of investment funds are invested in this fashion.

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