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The active/passive choice

10 August 2017 | Portfolio construction

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Creating investment portfolios for clients is a key role for advisers. The choice between active and passive investment strategies is at the heart of this role.

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I'm Ankul Daga. I'm an investment strategist at Vanguard. Let me explain Vanguard's framework for the active-passive decision that you can use with your clients.

The first question is: Are you able to identify outperforming managers? If the answer is no, you should consider a 100% passive portfolio. But as an adviser you have experience, you have the knowledge, you have the access to databases and research. You can use them to assess different fund managers. Maybe you have a short list of managers, or a long list. If you are able to devote the time and resources to this, you can apply our framework.

It has four critical factors. The first is gross alpha expectations. How much return do you think the manager will deliver over the benchmark before costs? Obviously, if you are expecting high gross alpha, you are more likely to have a higher allocation to active. If your expectations are low or uncertain, you're more likely to go passive.

The second criteria is cost. How much are you being charged for this active management? It almost goes without saying that the cheaper it is, the more likely you are to use it. After all, for every penny paid in costs is a penny taken out of your returns.

Active risk is the third factor. It is the uncertainty associated to a particular active manager. A high level of active risk means there is greater uncertainty about a particular manager's ability to deliver results. Another way to think about it is manager risk. The lower this risk, the more likely you are to allocate to an active strategy.

And finally, we have active risk tolerance. This is your client's willingness to take on the active risk I just mentioned. They take on this risk in pursuit of outperformance. As you would expect, the higher your client's risk tolerance, the more comfortable they will be with active strategies.

From this framework, we have developed a structured, repeatable and defendable process that considers different values for the four critical factors. You and your clients need to be deliberate in your assumptions about gross alpha, cost, active risk and risk tolerance. From there, you can tailor investment solutions to suit your client's specific circumstances.

Thank you for watching.


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Most of us blend active and passive funds in our portfolios. It makes sense. But how many of us make the choice through a process that is truly robust? Our newly developed framework can help you successfully blend active and passive investments.

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Related reading:
Actually, it's not a competition
Best of both worlds: Blending active and passive

Important information

This video is directed at professional investors and should not be distributed to, or relied upon by retail investors.

It is designed for use by, and is directed only at persons resident in the UK.

This video was produced by Vanguard Asset Management, Ltd. It is for educational purposes only and is not a recommendation or solicitation to buy or sell investments.

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

The opinions expressed in this video are those of individual speakers and may not be representative of Vanguard Asset Management, Ltd.

Issued by Vanguard Asset Management, Limited which is authorised and regulated in the UK by the Financial Conduct Authority.

VAM-2017-07-18-4927

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