Holly Cook: Regular viewers will know that Morningstar reiterates the importance of fees when making your investment decisions on a regular basis. Joining me today is Jose Garcia Zarate of Morningstar's passive fund research team. He's going to talk a little bit more about how to decide whether to go for an actively-managed fund or a passively-managed fund.
Jose, thanks for joining me.
Jose Garcia Zarate: You're welcome.
Cook: So let's start at the beginning, can you remind us what are the key benefits of passive investments such as exchange-traded funds and trackers versus the more actively-managed unit trusts or investment trusts?
Zarate: The key benefit is obviously the cost. Investment, by definition, is an uncertain business, and you never know what you're going to get. The only certainty of investment is actually that you have to pay something in advance. So, I guess it makes sense from the point of view of an investor to make sure that the costs that you know that you're going to have to pay are the lowest possible.
Cook: So, for an investor hearing that, they might say, well, that means I should always go passive because they tend to be the cheaper funds. But are there some areas of the investing world where it makes more sense to pay that extra for the expertise of an active manager?
Zarate: There are areas that perhaps are more suited to active management out there, for example. It depends very much on the value of information. For example, if you are investing in a very mainstream, very liquid market such as the FTSE 100, for example, or the S&P 500, the chances of an active manager actually adding value in that particular market is – has to be judged as pretty small. When it comes to more perhaps exotic markets such as emerging markets or frontier markets where the value of information is still pretty relevant, maybe a good active manager can actually add that extra value and it might make more sense to go active.
So, there's no clear ‘passive is good, active is bad’. I mean, it's a way of actually combining the two things.
Cook: So, where you can kind of get your hands on the research yourself and if you are willing to do so, perhaps passive makes more sense, but where it's harder to really kind of get the details you need to make a suitable investment decision, it can be worth paying for an expert to make that decision for you?
Zarate: If you know that the expert behind managing that particular fund is actually going to add the value, he's got more chance of adding value in that respect.
Cook: And so that's specific areas of the market, but what about are there any scenarios where it makes more sense to be active or passive, or types of investor where it makes more sense to be active or passive?
Zarate: As I said, by definition there are advantages to perhaps both passive and active investments, but when it comes to deciding what type of assets to invest in, it very much depends on the type of investor that you are, the situation in your life, and basically it all comes down to what we call asset allocation.
So, if you are young and you've got a kind of liberal attitude to risk, you perhaps would be more willing to take on higher exposure to, let's say equity markets, which are more volatile.
When you are approaching retirement, well, perhaps you should actually transfer away from the volatile and risky markets into the asset classes that are going to provide you with steady income and low volatility. So, rather than the passive/active debate, it's more kind of like an asset allocation debate in that respect.
Cook: So, once you've defined your asset allocation and then you're coming to the decision of actually which instruments are you going to utilise to achieve your financial goals, that's when you start looking – trying to weigh up whether you have the research handy, kind of what your risk assessment is and what the overall fees are?
Zarate: Exactly. I mean, two main things to take into consideration: the right asset allocation, and once you've decided what asset allocation you want, then you can go into deciding, okay, I'm going to devote this share of my portfolio to passive investments and this other share to active investments.
Cook: Great. Well, I think that's cleared up a few important factors for us. Thanks, Jose.
Zarate: You're welcome.
Cook: For Morningstar, I'm Holly Cook. Thanks for watching.