Passive Management

Passive management (also called indexing) is a portfolio management strategy based on purchasing exactly the same stocks and bonds, in the same proportions, as an index.  Indexing doesn't entail any forecasting, and any use of market timing or stock picking would not qualify as passive management.

The idea is to minimize investing fees and to avoid investment mistakes.  The most popular method is to mimic the performance of a specific index.  By tracking an index, an investment portfolio typically gets diversification, low turnover, and low management fees.

Passive management is most common on the equity market, where index funds track a stock market index, but it is becoming more common in other investment types, including bonds.

The rationale behind indexing stems from a simple concept:

In the long term, the average investor will have an average before-costs performance equal to the market average. Therefore the average investor will benefit more from reducing investment costs than from trying to beat the average.

However, some active managers beat the index in particular years, or even consistently over a series of years.  

In theory, portfolio managers don’t make decisions about which components to buy and sell. At the simplest, an index fund is implemented by purchasing securities in the same proportion as in the stock market index.  However, portfolio manager can also use sampling techniques (e.g. buying stocks of each kind and sector in the index but not necessarily some of each individual stock), and there are sophisticated versions of sampling (e.g. those that seek to buy those particular shares that have the best chance of good performance).

As passive management, index funds, and ETF’s grow in popularity grow the distinction between active and passive management is become much less clear.  For example, some index funds and ETF’s use sophisticated sampling techniques which is technically active management.  In addition, some index funds and ETF’s focus on narrow sectors of the market and do not tract the broad market.  These specialised funds (closet active managers) offer specialise products marketed as “index funds” or “ETFs” to capitalize on popularity of these investment vehicles and justify higher management fees.

Scout Investments offer comprehensive investment, insurance, and mortgage solutions at the lowest cost to our clients. 

kevin@scoutinvestment.ca                         

www.scoutinvestments.ca                                            

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