Passive investment hot air balloons

Hot air balloons also need piloting
Hot air balloons also need piloting Hot air balloons also need piloting

IN marketing any product, the aim of the marketeer is to make as much money from that product, often telling whatever story suits. Some are ethical, some are not. Some are just strange.

A financial adviser understands your current position and needs, and carefully constructs a bridge between the two, to give you and your family financial security, both now and in the future. Often this involves using financial services products.

Financial services companies create financial products and their teams promote those to financial advisers. That’s where the fun begins.

Your money (ISA, pensions etc) can be invested in passive and active managed options.

A ‘passive’ is where an algorithm effectively decides what your pension fund is invested into by buying what is in an index or sector i.e. FTSE All-Share. An active fund has a team of researchers and analysts who decide what you should be invested into, what sector and what geographical location and currency.

One argument created by a passive manager is to buy the cheapest passive funds, as most active management doesn’t outperform the market. A good active manager thinks differently.

In this old argument, you are comparing a plane and a boat. They are both taking you somewhere, but in very different ways. In stormy seas, or thunderstorms in the sky, they operate very differently with very different risks.

In a ‘much not talked about’ issue, no-one seems to know why central banks have pumped equity markets full of money. ‘That question is below my pay grade’ is not good enough from a financial adviser if your customers lose their shirt in a downturn. That is why most professional Independent Financial Advisers will use passives where they need to, investment trusts where they are a superior option, and active managed where that is the better option.

They then leave that to the very best managers to achieve the desired outcome.

An ‘all in’ option is never a good thing, i.e. all passive or all active.

The easy money policy by Mr Bernanke in the USA, followed by the UK and others was intended to boost wealth. Pumping ‘quantitative easing’ money into the economy was also about boosting perceived wealth. $7.7 trillion has been pumped into quantitative easing in the US alone. The UK’s monetary policy committee has pumped in £895 billion.

Bernanke publicly stated that higher perceived wealth through stock market prices will increase confidence, and in turn spending, which leads to higher incomes, and then profits which creates a positive feedback loop, which then facilitates economies to expand.

Whatever happened to the survival of the fittest capitalistic dream? The income and inflation hasn’t happened yet but asset prices have soared.

Quantitative easing can indeed lead to a serious problem within a wholly passive portfolio.

Central Banks’ strategies can effectively create a positive feedback loop which, as we have mentioned before, can create a bubble.

If you analyse passive funds during a time of momentum where all markets are just rising, they look great. They are cheap with access to a hot air balloon that just rises. Hot air balloons also need piloting.

When markets turn volatile, being as high up as you can with no pilot isn’t funny. There is no ability to manoeuvre and no-one to do the manoeuvring.

Put another way, it’s also a liquidity tsunami. Every boat will rise when there is more water, but there is a place not to be in a tsunami.

Most funds chase the current trend by default, in that the algorithm is simply buying the stocks in that index irrespective of their value or worth, or overpriced nature. They are in the index, therefore you get them.

When that trend turns, you, as an investor keep the stocks until long after they were obvious to sell as the passive isn’t actively managed. Similarly, they don’t take profits as and when they should whereas an active manager will shave off gains now and then.

And so, use the right solution for the right job, active or passive.

:: Peter McGahan is chief executive of independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority. If you have a financial question, call Darren McKeever on 028 6863 2692 or email or visit us on