Active investing | MoneyTalk

Technology has transformed our world. With a single tap or swipe you can pay your bill, book a room or a ride home.

Technology is making life simpler, easier and cheaper.

And investing seems to be no exception.

Today I’m joined by Fidelity’s Paras Anand to talk about one of the biggest investment debates of our time, active versus passive investing and what role technology has played.

Maike: Hi Paras, let’s start by explaining to our viewers the difference between active and passive investing.

Paras: In a passive strategy you effectively own a market portfolio that could be the global market or it could be a market like the US and you’re trying to get exposure to all the securities in the market according to the market cap that they have. Now for an active investor what they’re trying to do is look within the market for instances where they can find big differences in the price of the security and what they believe that security will ultimately be worth in the future and making a select subset portfolio that they think will outperform the corporate average.

Maike: How has technology changed the dynamics?

Paras: In a word cost and I think particularly the biggest beneficiary of that cost benefit is coming to passive investing. Actually the idea of passive investing has been around for just as long as active investing, but active investing is much more of a human endeavour. It requires people doing the research on companies, meeting companies and then making the investment decisions. For a passive investor they just want to own the market. So things like electronic trading price transparency, market liquidity, you know all of those things that we see as a result of the digitisation of our economy have brought down the cost of passive investing and hence we’ve seen this inexorable rise in the number of passive strategies in the market.

Maike: Advocates of passive investing argue why should I pay for an active investor when few active investors manage to outperform the market?

Paras: Well what’s unusual is that the case for active management actually grows because of the amount of passive management in the market.

Maike: Why is that?

Paras: Effectively the easiest way to understand it is that the growth of investors who don’t care about valuation, who are simply just owning the market without any attention to the difference between the price for what they pay and the value for what they pay means that the market becomes fundamentally less efficient. So there are more opportunities for active managers to exploit over time.

Maike: And that really is the job of the active manager right? Finding those market inefficiencies and mispricing opportunities?

Paras: Absolutely. What we see even if we look back over history is that there’s been a cycle to active returns. The other way in which active managers really contribute to individuals’ portfolios is that active structures have a good track record of preserving capital during weak market conditions. And you know we’re in the longest bull market since World War 2, so actually having active strategies in your portfolio is quite a wise thing to do at this point in time.

Maike: I guess that’s a key point Paras because of these market conditions, almost a decade of rising markets that has benefited passive investing, but few investors know what could happen if the tide changes.

Paras: I think that’s absolutely right. If I’m in a broad bull market then the primary consideration is cost. You know I want to get access to that return but I want to do it in the lowest cost way. But what happens when you’re in that environment is you stop thinking about the trade-offs between the price that you pay and the outcome that you might get, so therefore you pay a lower attention to preserving capital when you’re in a bull market.

Maike: Let’s get back to this point about technology changing our world. In all aspects, especially in industry, technology has made life simpler, easier, cheaper, but with investing it’s more nuanced.

Paras: I think that’s right. The easiest way to think about it and I made the point earlier, is actually the growth of passive investing, has made the market more inefficient. So the difference between that and other forms of technology, let’s say Netflix vx linear TV, what I do when I’m watching television doesn’t influence at all what you do when you’re watching television. But in a market system the behaviour of a certain set of actors shapes the outcome for a different set of actors, so therefore it’s not a case of where you know let’s say the cost benefit of passive or the cost benefit of technology for investing basically has a one way structural benefit it creates. It creates differences within the market but differences where active investors can exploit them.

Maike: To close let’s explain how active investors can tap into these market inefficiencies and mispricing opportunities.

Paras: This is an area where you know whilst technology can improve the analytical process it is in the end quite a human process. You know it is the process of identifying that big long term difference between the price you pay for a security and what you think it’s ultimately worth over time and it’s different to passive investors, it’s a kind of forward looking endeavour, you’re not making decisions based on the past, you’re making decisions based on expectations of the future.

Maike: Paras, thanks very much for those insightful views on active vs passive investing and the role technology has played.