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Active vs passive is like prepackaged vs gourmet pancakes.

What is active management?

‘Active management’. It’s a term, like many in the finance world, that is jargon for a simple concept. Simply put, active management is where decisions regarding an investment are made by the analysis of investment professionals, sometimes with quantitative tools to assist.

Imagine you wish to make pancakes. You can buy an off the shelf pancake mix (passive management). This is a recipe that you, the chef, have no control over as it is pre-packaged. It’s a one size fits all approach. Basic. Active management is like making pancakes from scratch to achieve a desired outcome or meet a specific taste. That outcome might be to maximise returns (extra tasty pancakes), to invest sustainably (organic pancakes) or to provide monthly income, like the eInvest Income Generator Fund (managed fund).

Similarly, you can buy a portfolio of stocks in a passive index product where rules determine what that index is constituted of. An actively managed investment (e.g. active ETF) has a team of investment professionals who oversee the portfolio. They will make changes to that portfolio in response to the views and analysis of the team.

The ways the portfolio manager adapts the ‘recipe’ (portfolio) can include:

  • The portfolio manager can switch out stocks (‘ingredient’) to respond to changes to price, the market, trends and changing views on that asset’s desirability
  • The portfolio manager can increase or decrease the amount or number of any “ingredients” or holdings to influence the overall construction of the portfolio
  • Investing, like cooking, is both a science and an art. The portfolio manager must weigh both the quantitative and qualitative data.
  • A good portfolio manager will meet the management of the companies. This firsthand knowledge, just like squeezing a tomato in a farmers market, is important in assessing the quality of the asset beyond the numbers and spreadsheets.

So, when choosing an investment, ask yourself: do you want an pre-mixed investment? If not, how do you like your pancakes? I like mine using organic wheat, buttermilk and blueberries.

 

Jodi is a millennial investor and an investment relations consultant at eInvest. This article is the opinion of the author and is not financial advice. Speak to your financial advisor or broker for more information. I’m sure they’ll be happy to help you. Don’t forget to always read the Product Disclosure Statement (PDS) for the active ETF you are invested in.