Insights

Combining Active and Passive Investments: More Art than Science

Although the polarizing active versus passive management debate persists, more sophisticated investors have found that the real question is not whether to choose active or passive strategies, but how to combine the best of both approaches in a holistic way to seek the most beneficial portfolios for clients. This newfound middle ground hinges on a new definition of what it means to be an active investor.


While historically, active management referred to individual security selection, today, with an unprecedented number of investment tools at their disposal, investors seek alpha at the asset class, country, sector or even industry level. Furthermore, smart beta strategies that offer a hybrid path — blending the alpha-generating potential of active management with the low cost of passive approaches — have gained a following.

How you combine active and passive strategies for your clients depends on everything from your market outlook to your investing philosophy. Other factors that may drive your decision to use one strategy over another include sensitivity to fees, diversification, and the pursuit of alpha maximization.

Figure 1: The Definition of “Active Investing” Is Changing

Here we share ideas for combining active and passive strategies that we have seen implemented by our financial advisor and institutional clients.

Fee Reduction and Tax Efficiency

Investors seeking to minimize fees and tax liabilities may consider emphasizing index products.

Diversification

Index investments may provide increased diversification to portfolios concentrated in a small number of individual stocks, or they may be used to round out a fixed income exposure.

Alpha Maximization

The pursuit of alpha maximization may be achieved by mixing active and passive investments based on market efficiency and managers’ historical ability to generate alpha in the asset class.


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