Balancing active and passive portfolio styles

Balancing active and passive portfolio styles

Refining your investment strategy


“Active” and “passive” portfolio management used to be fairly straightforward. Active investors traded frequently in individual stocks in an effort to beat the market, while passive investors relied on index-following mutual funds and exchange-trade funds. But the line between active and passive has become increasingly blurred, with the advent of ETFs that are either partially or fully actively managed.

Actively tactical and strategic

Active investors are the very essence of portfolio tinkering. It’s almost as if they can’t leave well enough alone in the quest for that extra point or two of return. They’ll buy and sell securities, including investment funds, on the basis of specific criteria (often when a price target has been reached) and allocate portfolio assets tactically or strategically.

Strategic asset allocation shifts assets within a portfolio to hold to predefined objectives. For example, with a portfolio oriented more to growth type of investing, you might have your assets divided in a ratio of 65% equity to 35% fixed income.

But if the equity portion of your portfolio (including equity mutual funds and exchange-traded funds) increases to 75% as a result of rising equity markets, the equity portion of your portfolio will need to be rebalanced back to 65% to be in line with your original investment objectives. The active investor may decide to sell the excess 10% equity and purchase an additional 10% on the fixed-income side. That’s called a “strategic asset allocation policy.”

Tactical asset allocation attempts to capitalize on shorter-term movements in the markets. This may involve allocating assets in different sectors in an attempt to provide short-term profits based on your outlook. Or the investor might consider shifting to 90% equity exposure and underweighting fixed-income for a short time if their research indicated markets were verging on a rebound from a lengthy bearish period. Conversely the investor could move to a heavier weighting in cash and fixed-income allocations if they felt the markets were going to fall or correct.

Passively following the market

The passive approach hinges on the belief that the market is generally efficiently priced, and as such, it makes no sense to attempt to “beat” the market, because over the long term, portfolio returns “revert to the mean” – they’ll end up pretty much reflecting broad market returns anyway.

Using the passive investment approach, investors simply buy a piece of the entire market instead of trying to make a call on which company or asset class will do better than another.

To accomplish this, an investor would buy a series of both equity and fixed-income index mutual funds or exchange-traded funds (ETFs) that replicate the performance of a market index, and simply hold them. Because ETFs generally track an underlying index, and therefore require no ongoing management, they are cheaper than mutual funds, with an average MER of 0.5% compared with 2.5% for actively-managed mutual funds. That means you put 2% more in your pocket, and you achieve diversification because you have bought the entire market.

“Active” passives?

But the ETF world has changed dramatically, with ETFs now available that track indexes designed to mimic various types of “active” characteristics, for example, mechanically weighting holdings according to earnings fundamentals, or estimations of future volatility, rather than by pure market capitalization as traditional index-tracking ETFs do. An entire investment industry has sprung up in which managers “actively” build portfolios consisting entirely of “passive” ETFs. This certainly reduces costs, but really fudges the line between “active” and “passive” investing strategies. So are these types of ETFs “active” or “passive”? Are you buying what you believe to be a “passive” investment, but one with a higher risk ranking because of its “active” characteristics?

As you can see, there are investment risks associated with the passive approach, as there are with any investment strategy. Even with broad market indexes, if the markets drop steeply, your portfolio will drop right along with it.

Many investors have solved this problem by using a passive base strategy with an active overlay. By using this approach, you ensure have exposure to the broad markets, while adding a small active component to capture excess returns over market performance.

Robyn Thompson, CFP, CIM, FCSI, is the founder of Castlemark Wealth Management, a boutique financial advisory firm specializing in wealth management for high net worth individuals and families. Contact her directly by phone at 416-828-7159, or by email at for a confidential planning consultation.

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The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned are illustrative only and carry risk of loss. No guarantee of investment performance is made or implied. It is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. Please contact the author to discuss your particular circumstances.