What are the Benefits of Passive Investing?

Passive funds are precise tools that asset allocators can use to get exposure to different markets - although they are not risk free

Emma Wall 25 June, 2015 | 11:13
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Emma Wall: Hello. Welcome to the Morningstar series Ask the Expert. I'm Emma Wall, and I'm joined today by Shaun Port, CIO, Nutmeg. [Nutmeg is an online discretionary investment management company in the UK.]

Hello, Shaun.

Shaun Port: Good morning. 

Wall: So we're running an active and passive week this week, and today we're focusing on the benefits of passives. So I'm just going to say to you, what are the benefits of passives?

Port: Well, often people think of passives as just being a bit like your basic foods you get in the supermarket, Value Baked Beans, but they are much more than that. They are really precise tools that people like me, asset allocators can choose to get good exposure to different markets, be very precise about where we are investing in, know what we are investing in, and obviously, we got to see what we've got and actually at very low cost and really reliable returns. So, if the FTSE is down by 1%, we know we're going to be down 1%, but if the FTSE is up, we know we're going to be up.

Wall: That's one of the things you mentioned, they are not just about basics. I think many people think of passive funds as a way to gain access to say the most liquid of equity markets. But actually they are incredibly diverse. If we take one sector, for example, commodities, finding an active manager that invests directly in commodities and in the underlying natural resource is very difficult; the Barings Fund now it's just equities only; the JP Morgan is equities only. So with a sector like commodities, passives can really offer something completely unique?

Port: Yes, so you can target the mining sector if you like the stocks or you can target the physical commodities by investing in funds that invest in future. So whether you like energy, whether you like best base metals or agriculture, there are ETFs particularly that will invest in those commodities. If you fancy the stocks, there is ETFs to those as well.

Wall: What do you think that passives bring to a retail investors' portfolio that perhaps active management can't?

Port: Well, I think they're really good for core part of particularly equity portfolios, long-term buy and hold. If you think about the costs now for investing in the FTSE 100 exchange traded funds, that cost you £7 per year for £10,000 invested. That's incredibly low cost, and it makes it quite hard to beat that kind of low cost. So, that's really great building block for a portfolio to think about where do you want to invest. If you like, for instance, that you prefer one emerging market country rather than invest in the whole of emerging markets, you can be selective. And same in Europe; if you just like German stocks rather than a Pan European Fund, you can buy a German Index Fund as well. So, there is a lot of precision that investors can use out of these, yes, whether they're retail or whether you're institutional.

Wall: There's one thing we should mention though, they are not risk free. I think a lot of people think of passives as a one way bet, but, of course, although, you're never going to underperform the market, asset allocation is really key because it's important to diversify, because if the market goes down, you're going to go down. So if you are only invested in that one market, that's all your money gone.

Port: Absolutely. I think what exchange traded funds and index funds give you is the ability to asset allocate. To choose where you are invested, but it's really important you follow that next step and invest where you should be investing, being really diversified across the world, across different asset classes and index funds and allow you to use those different asset classes really effectively.

Wall: Shaun, thank you very much.

Port: Pleasure.

Wall: This is Emma Wall for Morningstar. Thank you for watching. 

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Emma Wall  Emma Wall is Editor for Morningstar.co.uk

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