Passive management is not new, but it is an incredible novelty in investment funds and savings control for retirement. So much so that in 2016, it was left with 86% of the new money that went into funds worldwide. Although inequity, it still only accounts for 28% of the total.
The attractiveness of passive management focuses on the ease of understanding its operation, lower costs, good diversification, new technologies, and a community of loyal eager to share their portfolios, which communicates with the value investment so fashionable.
What is Passive Management?
To understand passive management, we must confront active management, the most traditional. The main difference is that in the first, the role of the manager, who is responsible for moving the money to obtain profitability, is much more dynamic. Money moves more to receive more benefits. This implies a series of commissions per operation and a larger team of managers that analyzes the market to overcome the average profitability.
On the contrary, the passive management model uses products limited to replicating an index like the Ibex 35. Hence, it is also known as indexed management. In this case, the objective is not to overcome the market but to replicate it and do the same.
An investor who bets on passive management will use several products replicating indices and even whole sectors to build an investment portfolio as an investor in traditional funds would.
Advantages of Passive Management
Like any style of investment, passive management has its advantages and disadvantages. Its most important strengths are the following:
Lower Costs
Passive management is cheaper and transfers fewer costs to the investor. The reason is easy to understand when a fund’s objective is to replicate the market instead of overcoming it; the management is much less complex, so many operations are unnecessary, and the management team is much smaller.
One only must look at the differences between the commissions of an investment fund and an ETF, the star product of passive management. The commissions will surpass 1% in the first, while they will not reach 0.5% in the second.
A Reasonable Degree of Diversification
Diversification is assured by investing in a specific index, sector, and category. Another question is the geographical one. To understand better, if you buy an ETF on the Ibex, you are betting on different types of companies in the same country.
Fortunately, there are also global ETFs and even a single sector.
Easy to Access
Accessing ETFs and other passive investment tools is becoming easier thanks to new technologies. The outbreak of Fintech has led to the emergence of platforms where, for a short time, it is possible to start investing in these types of products and let the savings revalue at the same pace as the market.
Finally, although we have already mentioned it, many users are willing to share investment portfolios and strategies based on passive management. Try typing “Bogelhead” on Google, and you’ll find one of the most active communities.
Risks of Passive Management
Replicating Does Not Guarantee Success
The stock market has always risen in more than 15 years, but replicating an index is no guarantee of success. The Ibex, for example, does not always rise and may fall as a fund or an action will. The key to passive management is to make periodic contributions to compensate for periods of ups and downs.
Tax Doubts
Most passive management strategies are carried out through ETFs or listed investment funds. These funds function as stocks since they can be bought and sold more quickly than a traditional fund.
The problem is that its taxation is also that of the shares, at least for Spanish ETFs. This means the reinvestment exemption cannot be applied, and you must pay taxes whenever you want to undo a position. There is now some controversy about the taxation of ETFs of foreign managers (the majority) and the possibility that they could benefit from this advantage.
Biased Diversification
As much as an ETF replicates an index, if it is limited to one of them, the diversification will be relative, as we have already seen. A combination of ETFs will be necessary to diversify the portfolio and avoid risks.
In the end, passive management is an excellent complement to active management. Both do not have to be faced, and a portfolio can combine strategies that include products of all kinds.
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