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Portfolios need active-passive mix

Investment portfolios should consist of both active and passive investment strategies as longer-term market cycles favour both approaches at different points, according to a fund manager.

Perennial Value Management head of retail Cesar Farfan said investors have benefited from having a combination of the strategies as both play a role.

“There is no one-size-fits-all in the active versus passive debate. It’s all about portfolio construction as even within a typical balanced portfolio the weightings to different sectors and strategies can lead to big discrepancies in performance,” Farfan said.

The firm’s research showed the average Australian active manager had faced a difficult period relative to the S&P/ASX All Ordinaries Accumulation Index over the past 10 years as it was a period of lower stock dispersion and higher stock correlation relative to longer-term averages.

However, active managers have outperformed in other periods when market conditions have favoured harvesting alpha.

Perennial Value Management portfolio manager Stephen Bruce said: “Active managers were shown to outperform the most during periods of higher stock dispersion and lower stock correlation.

“We have been in a largely macro-driven market post the global financial crisis, distorted largely due to central bank intervention, namely quantitative easing. We are now going into a new cycle with synchronised global growth, quantitative tightening and perhaps increased volatility.”

The research comes in the wake of increased inflows into passive investment products, with global exchange-traded fund assets under management topping $4 trillion in May 2017. But Bruce warned investors not to rely only on passive investing to generate consistent returns.

“Overweighting a portfolio with purely passive products means investors will potentially miss out on significant alpha in certain market conditions and market sectors,” he said.

“It can also leave investors exposed to greater sequencing risk as the research also shows that active managers tend to perform better in down markets.”

Farfan said given the market is heading into a higher-growth, rising interest rate and volatile environment, investors should consider reweighting portfolios and adding more active elements.

“That said, the development of passive products has had a lot of positive effects on the funds management market in general, with active managers responding to investor demand by shifting to listed structures, lower fees and an increased focus on absolute returns,” he said.

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