Active or passive? Process, not politics, should drive choice of strategy

By Dan Hallett, CFA, CFP on January 24th, 2012

The National Post’s Jonathan Chevreau recently asked me and a few other financial professionals how we plan to invest this year’s tax-free savings account contribution.  The way my reply was framed may have given a somewhat different impression than intended.  But it also touches on a common misconception.

The active-passive continuum

The article correctly quoted my plan to add to my personal exposure to global stocks by dividing my contribution between Vanguard Dividend Appreciation ETF for U.S. stocks and Mawer World Investment for overseas stocks.  The article prefaced this reply with the notion that I was “…torn between a mutual fund and an ETF“.  While unintentional, this paints both my plans and the broader active vs passive decision in the wrong context.

I wasn’t torn at all.  Too many view passive and active investment as mutually-exclusive strategies decided upon via some quasi-political debate.  On the contrary, I view active and passive as two strategies on the same continuum.  Indeed, the ETF industry – once synonymous with passive investing – has created a blurring of the lines between active and passive strategies.  The likes of Fundamental Indexing, equal-weighted indexes and other quant-driven indexes are pushing so-called ‘passive’ approaches closer to the active management side of the spectrum.

That notwithstanding, as highlighted in my most recent Investment Executive article I am indifferent between passive and active investing – a view shared by my HighView partners and, accordingly, written into our firm’s investment philosophy.

Process-driven selection

Much like our firm does for clients, my selection of specific products was the result of a broader goals-based process.  I first considered my goals (i.e. long-term growth).  This, along with an assessment of the level of risk that I need and am willing to take to achieve that goal, and my current asset mix, pointed me in the direction of global stocks.

Only then did my focus turn to the universe of products available to meet my need for global stock exposure.  At this stage, I looked at the possibility of a stand-alone global fund versus a strategy of combining separate U.S. and overseas funds.  Philosophically, I prefer global funds because I like putting a more flexible mandate in the hands of a skilled manager.  But a sufficiently-large cost savings could instead compel me to go with two separate funds.

So my choices were among a small list of global funds with annual fees of 1.5% to 1.7% annually; or the above two-fund combination at 0.87% annually.  There is no definitive answer but I chose the latter option since the prospect of saving 80 basis points annually (on that slice of my portfolio) was enough to induce me to compromise on my usual preference.

The best of both worlds

The industry’s proliferation of investment products provides an abundance of choice.  Too much choice is generally a bad thing for most people.  But now financial advisors have access to a good universe of ‘passive’ mutual funds and ETFs.  Do-it-yourself investors also have the ability to construct cheap portfolios of actively-managed or passive investment products.

But don’t let an age-old industry debate drive product selection or force the taking of sides.  Rather, take a sound process-driven path to selecting investments and consider blending the best of available passive and active products.  It just may help further tilt the investing odds in your or your clients’ favour.