A guide to active and passive investing
By Robert Wright /August 17,2020/
Investment funds can be broadly split into two categories – active and passive. And while both options play a part in an investment portfolio, it’s important to understand how each works before allocating money to them.
Basics of passive investing
Passive investing has gained momentum in Australia, and beyond, over the last decade. It could be because this style of investing aims to replicate the returns of a particular market index (for example, the S&P ASX 200 Index). This means, that when the value of the index rises, so too will the value of the fund. On the flip side, as the value of the index falls, so too does the nature of the fund.
Exchange-traded funds (ETFs) are some of the most popular passive investments. They are similar to managed funds, in that they involve a trust structure which holds a basket of securities.
As described above, the investments in the fund replicate the make up of the relevant market index. For example, if the index is made up of stocks that include banks, mining businesses, retail companies and supermarkets, the ETF will also hold these stocks.
Units in ETFs are listed on stock markets and can be traded just like shares.
It’s important to note, that while there are also actively managed ETFs, passive ETFs are most common of the two.
Basics of active investing
In contrast, an active approach to investing involves a fund manager choosing the assets in the fund, depending on the manager’s view of markets and the type of fund it is.
Like passive investments, there are many types of actively managed funds which offer exposure to different asset classes and industries. Rather than track an index, an active fund will target a return above a particular benchmark. An example of this is, every year, an actively managed fund might aim to achieve the same return as the S&P ASX 200 plus two per cent.
Another common way of measuring the performance of an active fund is for it to target a premium above the rate of inflation. For example, a fund might aim to achieve inflation plus two per cent per year.
Cost benefit analysis: fees
Cost is one of the major differences between these two styles of funds. Typically, passive investments are lower cost, as investors are not paying for the fund manager’s expertise in choosing the investments in the fund.
Active funds, on the other hand typically charge a base fee and a performance fee, to incentivise the fund manager to produce the highest possible return.
It’s important to remember that markets will always go up and down, and actively managed funds still have many benefits (as well as risks) while factoring:
- Funds that track an index only produce the return of the index
- Fund manager skills can be used to pick investments that have the potential to do well when economic growth is slow and markets are falling
- Active managers can also avoid stocks and sectors that are not doing well.
It’s very difficult to get a true picture of whether actively managed funds perform better over time versus passive funds. It’s probably more instructive to think about how each style of investing is used in a portfolio.
A balanced perspective
There’s really no right or wrong approach when it comes to investing in active and passive investments. Many investors choose to invest in a combination of the two styles to achieve a level of diversification in their portfolios and to get access to a broad range of asset classes across the risk spectrum. Source: BT
Dividend cuts – what can investors expect?
By visual /May 13,2020/
Since the financial crisis more than a decade ago, investors have had to search much harder for income as savings rates have plunged.
Many have looked to the equity market to help them achieve better income returns, with large numbers of companies increasing dividend payments to shareholders as they have grown.
It is likely that equities will continue to provide a relatively attractive source of income for those comfortable with the risks of investing in the stock market. However, regrettably, dividend payments for most equity income investors are likely to be lower than in previous years for the foreseeable future as a result of the coronavirus crisis.
Here we explain why and give our views on the outlook for dividend payments over the medium and longer term.
The equity income fund model
Equity funds that have a focus on investing for income as well as the potential for capital growth are called equity income funds.
A dividend is an income payment from an investment. The dividends that investors receive from an equity income fund directly reflect the dividends received from companies that the fund holds shares in. This money is paid out to unit or shareholders in proportion to the size of their holdings.
One aim in managing an equity income fund can be to increase dividend payments to investors over time. A manager may aim to achieve this through focusing investment on successful businesses that have the potential to increase their dividend payments as they increase their profits. The income and capital value of an equity income fund can go down as well as up and investors may not get back the amount they invest.
How the coronavirus crisis has impacted companies’ dividend plans
The coronavirus crisis has blown the carefully laid plans of large numbers of companies around the world way off course.
For the time being, the revenue streams of many good businesses have been drastically reduced. And for some, in the most exposed sectors, they have effectively evaporated. All the while, there are costs that must still be met alongside obligations towards key stakeholders including employees, customers and suppliers.
As in any crisis, there are exceptions – some supermarkets, for example, have experienced a surge in sales during the lockdown period – but the management of a great many companies now have a single overriding focus: navigating their way through the current unprecedented conditions as best they can.
It should therefore come as no surprise that many companies have announced that they are reducing their dividend payments or in some cases, suspending them entirely. In most cases we believe this should be welcomed in the short term as it will provide necessary funds to shore up businesses, helping them to ensure their long-term viability once the immediate crisis has passed.
We expect to see more companies follow suit over the coming months, with many likely to err on the side of caution in setting their dividend policies, given the high degree of uncertainty we are all living with.
Companies that have been forced to accept Government assistance will find it difficult to continue paying dividends. And in some countries, banks have been instructed not to pay to a dividend to preserve capital so that they can provide finance to companies that need it.
The knock-on impact on equity income funds
When investing in equities for income you are left with a choice between trying to maintain the level of your dividend income or accepting that it will fall.
Importantly, this does not have to mean abandoning an aim to grow your income over the long-term. This can sensibly remain a key consideration in your stock selection. Instead you may wish to consider each company on an individual basis, assessing how well they are positioned to come through the crisis without fundamental changes to their long-term business case, which will impact their ability to pay dividends going forward.
An insistence on maintaining the dividend of an equity income fund in the current environment would, in most cases, force you into investing in a narrow, less diversified range of stocks. Accepting a cut in the dividend on the other hand can allow you to maintain a focus on investing in the companies that are most likely to help you achieve your long-term objectives in both income and growth terms.
Bouncing back following a crisis
In the wake of crisis situations, companies that have cut their dividends to prioritise cash holdings that enable them to operate and trade effectively can often recover faster than those that have blindly pursued the maintenance of dividend targets set in a completely different environment.
When the economic environment improves, these companies have the potential to restore and grow their dividends again from a position of comparative strength. A look at past crises shows that the overall impact on the intrinsic value of a business from a temporary dividend cut is generally small and, for long-term investors, it is important not to lose track of that fact amid the short-term market noise.
The outlook for dividends and equity income investors over the medium and long term
The shape of the recovery from the coronavirus crisis remains far from clear. There are indications that the strict lockdown conditions in place in many countries could be relaxed reasonably soon, enabling some limited activity to resume.
Realistically however, we all face a long wait for anything approximating ‘business as normal’ to resume, given that the only route to achieving this appears to be the development and implementation of an effective vaccination programme on a global scale.
This is unlikely to come together until well into next year, even if one of the vaccines that have already begun human trials proves effective.
This means that dividend payments over the next three years or so are likely to remain well below levels seen in 2019. There is no precedent for the current crisis but estimates of the eventual cut in dividends for the UK market as a whole in 2020 have so far ranged from around 25% to as high as 50%.
Longer term, a return to ‘business as normal’ for the economy is likely to lead to a return to ‘business as normal’ for dividends and by extension equity income funds.
It is possible that we could begin to see more companies around the world adopt more conservative dividend policies along the lines of Asian businesses. However, the aftermath of past crises would suggest that while companies may change their behaviour for a couple of years, they often then revert to the way that things were before.
How do Managed Funds work?
By Robert Wright /September 02,2019/
If you want to diversify your investment portfolio to spread your risk across different asset classes, sectors or geographic markets, you may be limited by the amount of money you have available to invest.
Managed funds are popular with investors looking to build their wealth over the long-term. By pooling your money with a group of investors, you can tap into much wider opportunities (such as infrastructure or overseas markets) that would be out of reach as an individual investor.
Want to invest in Brazil’s economy, or agribusiness ventures? You’re likely to find a managed fund that will give you access to that investment opportunity.
What is a managed fund?
A managed fund pools multiple investors’ money into a fund, which is professionally managed by specialist investment managers. You can buy into the fund by purchasing units, or ‘shares’. The unit’s value is calculated daily, and changes as the market value of the assets in the fund rises and falls.
Each managed fund has a specific investment objective, typically focused on different asset classes and a specific investment management philosophy to provide a defined risk/return outcome.
For example, the investment objective of a fixed interest managed fund may be to provide income returns that exceed the return available from other cash investments over the medium term.
Why invest in a managed fund?
There are three key advantages a managed fund brings to your investment portfolio:
1. Diversify to reduce risk
By investing across different assets classes – and within different types of shares within asset classes – you can spread the risk of your investments falling due to market volatility. You can also balance different investment timeframes and income returns.
For example, investing $1,000 in a managed fund could give you exposure to 50 different company shares in an Australian equities managed fund. But to invest that amount in 50 companies as an individual would limit you to companies with low share prices (and cost a significant amount in brokerage fees).
2. Expert fund managers
Selecting individual stocks is also time consuming, and requires a certain level of market knowledge. Professional fund managers have access to information and research, and have the processes and platform access to manage your money effectively.
3. Reinvesting brings compound benefits
You can invest regular amounts into your fund, just like a savings account. And by reinvesting your fund’s distributions you could ‘compound’ your investment returns. Effectively, any future interest payments will be a percentage of a growing amount.
Are managed funds good for income or growth?
You usually get two types of returns from a managed fund:
- Income is paid to you as a ‘distribution’, which you can easily reinvest back into the fund
- Capital growth if the unit price of your investment grows over time
If you’re more interested in capital growth, you’ll need a longer timeframe for investing – and these funds usually carry a higher risk.
Types of managed funds
When you’re comparing managed funds, look at the asset allocation to understand its risk profile and potential performance.
- Income funds – low risk of capital loss, focus on defensive, income generating investments such as cash and fixed interest.
- Growth funds – longer-term (5+ years) investments, focused on capital growth rather than income and weighted towards securities and equities.
- Single sector funds – specialise in just one asset class, and sometimes a sector within that class (such as Australian small companies).
- Multi-sector funds – diversified across a range of asset classes, with varied risk levels.
- Index funds – aim to achieve performance returns in line with a market index, such as the ASX 200. Also known as exchange traded funds (ETFs) or passive funds.
- Active funds – an actively managed index fund that aims to outperform that index.
There are also multi-manager funds, which invest in a selection of other managed funds to spread your investments across different fund managers.
Who should I talk to about managed funds?
To find out more about managed funds, please contact us.
Source: Colonial First State