This article is part of the Morningstar's Guide to Active vs Passive Investing. Click here for our edit on how the experts use the tools at their fingertips, finding out whether you prefer one to the other and examining how to blend active and passive investing for profit.
Emma Wall: Hello, and welcome to the Morningstar series 'Ask the Expert.' I am Emma Wall and here with me today to talk about the benefits of passive investing is Chris Williams of Wealth Horizon. Hello, Chris.
Chris Williams: Hi, Emma.
Wall: So, your portfolios blend passives for investors.
Williams: That's right.
Wall: What are the investors getting from passive funds that they are perhaps not getting from active funds? What are the benefits of passive investing?
Williams: Well, I think for the majority of our clients their needs are fairly straightforward and we encourage them to understand the risk and return characteristics of their portfolio over a longer period of time. We therefore believe that an important part of getting the returns that they expect is about consistency and it is about really setting their expectations and delivering those returns in the most cost efficient manner that we can do.
Wall: So, I suppose what you're saying there is, cost is one of the few predictable elements of investing and with passives that cost is low.
Williams: That's absolutely right. I think when you consider the range of active funds in the marketplace; if you set aside for one minute the outperformance of the market that they may or may not be able to achieve and the ability to predict the level of performance that an active manager can provide you with, the costs associated with them can be quite a high proportion of the returns that you're getting.
If you take that really for over the last 100 years the returns from the equity market have been in the region of about 5% per annum on average and then compare that to potentially the costs that you're incurring as an active investor, by the time you add in fund management charges, when you add in the adviser charges, any wrap charges or discretionary management charges and they go on and on and on, you could be paying up to 3%. So, the level of return that you're getting after charges is really quite poor considering the level of risk that you are exposing yourself to. So, we believe that being able to keep those costs down over the longer term will certainly provide the investor with a much more predictable return.
Wall: I think a lot of investors are now waking up to the benefits of passives and perhaps are dipping their toe in looking at the more efficient equity markets. But passives aren't just for the likes of the S&P 500 tracker, are they? They can be used for all types of asset classes?
Williams: Absolutely. I think a popular approach that has been taken over recent years has been the core vs satellite approach where the core of your portfolio is in the established market and is generally provided by a range of passive funds. The satellite approach or the smaller elements of more sophisticated market have then been provided by active portfolios. You can see the logic for that in terms of there may be slightly more complex markets, there may be better opportunities for an active manager to potentially provide outperformance. But we believe that actually there is such a range of passive portfolios these days that it makes sense to not just restrict the passive portfolios to the core elements of your portfolio.
Wall: Chris, thank you very much.
Williams: It's a pleasure.
Wall: This is Emma Wall for Morningstar. Thank you for watching.