Active Vs Passive Flashcards
What are methods of tracking underlying index in a passive fund?
Sampling/stratification
Optimisation
Futures/synthetic
Full Replication
What is the sampling/stratification method?
Buys some/a sample of index constituents
What is optimisation method?
Uses computer model/algorithm
What is synthetics method?
Uses derivatives
What are the advantages of active management?
Potential for above average performance
Can take advantage of investment opportunities
Can minimise effects of a market downturn
Benefit from research into new investment opportunities
What are the disadvantages of active management?
May underperform when compared to an equivalent passive fund - no added value
Charges may be higher
Past performance can’t be guaranteed
Research may not be good enough
What is the difference between active management and passive management?
Active management - a fund manager decides which underlying investments a fund will invest in within the constraints of the fund description (e.g UK Equity)
Passive management - a fund manger copies an index and invests in the same assets as the index
What does full replication mean?
Invest in all companies in an index with the amount invested matching the market capitalisation of the company.
What are the downsides to full replication?
If share prices rise/fall significantly fund manager would have to make sales/buys to rebalance to match index = trading costs which will increase cost of fund
Memberships of indices are reviewed so would have to sell those leaving the index and buy those joining = trading costs
After charges would underperform index
What is partial replication?
Fund manager invests in an agreed percentage of the companies index, but amount invested in any one sector must match the size of the sector in the index.
What benefit does partial replication have?
Fund manager can select which companies to invest in
Can reduce trading costs by selecting companies unlikely to fall out of the index
What is a downside to partial replication?
Research into which companies to invest in adds to the cost of the running of the fund
What are the advantages of passive investment?
Matches performance of the index
Can minimise effects of market downturn - partial replication
Partial replication can mean fund benefits from research into new investment opportunities
Charges are likely to be lower than with an active fund
What are the disadvantages of passive investment?
Underperformance of index after charges (full)
Past performance can’t be guaranteed
Research may not be good enough
What are ETFs?
Index tracker funds
Listed and traded on major stock exchanges
Open ended - Trades close to NAV
Designed to match return on index tracking
Price updated real time as listed
Can be classed as UCITS & held in an ISA
Can be synthetic
