Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 242

Let's refocus the active v passive debate

How did we find ourselves here? It’s a question I ask myself whenever I read an article or when I’m drawn into a discussion comparing index fund returns with the after-tax returns of active fund managers. And I’m asking it a lot lately.

I head up AMP Capital’s Multi Asset Group. The debate is usually misdirected by the time it gets to me, given that the multi asset management process picks from different styles and strategies – including low-cost index strategies where it makes sense – to come up with a blended approach designed to meet an outcome for investors.

I’m an advocate for investing in index funds in the right place at the right time when it is appropriate for the investor’s goals. I enjoy a thoughtful discussion about the role both active and passive strategies play within a portfolio to help clients meet a desired outcome. Our returns are judged after fees and it’s in our interests to keep costs down.

However, as someone who works within a traditional active funds management business, I find myself addressing some of the inconsistencies in this well-worn ‘for and against’ active versus passive argument, and invariably I’m left frustrated by where the debate ends up.

The wrong argument

What clients really need from asset managers is help delivering their financial goals. Financial goals, in my experience, are absolute and relate to growth in capital to fund retirement. They’re about delivering a level of income every year or over whatever period with confidence. As investment managers, we need to deliver this with limited surprises along the way.

Rather than focus on goals, the industry has instead taken on this benchmark-aware mindset, mainly because it’s an easy way to compare ourselves to our peers.

The funds management industry has gone so far down this benchmark-aware path that we’ve not only convinced ourselves but also our clients that we’re only doing a great job if we’re beating the benchmark. We’ve created this narrative at the expense of explaining what really matters to clients, which is their goal.

It’s unrealistic to scrap benchmarks totally as they do have merit. They are best used as a performance measurement tool rather than a metric for client success. I’d like to see more fund managers reposition the performance component so it’s more about whether a client outcome has been reached. This will take some time. I believe, though, it will also have the positive effect of encouraging greater client engagement.

Clients are moving away from that middle ground best described as ‘core benchmark-aware products’ where they were paying a high management fee for something that’s essentially the benchmark. It was not great value for them. They are rightfully moving into either very low-cost products or, at the other end of the scale, cost-effective but much more differentiated products where they also get value for their (typically higher) management fees.

Trust is key

The problem facing the funds management industry is one of trust. Active fund managers are not always trusted to deliver performance because some managers dressed up essentially index funds as actively-managed and charged 1% or more in fees for the privilege.

The only thing clients can trust is cost. It’s the only tangible thing they have.

In reality, there are far more opportunities to deliver great outcomes for clients beyond focusing on cost alone. If we design great products to meet client goals and get the alpha component right, we can deliver much more beyond the savings investors are seeking by shunning active management and marching into passive funds.

More than a few things have gone right for the index funds’ recent narrative, which has fuelled investor demand for low-cost passive funds. However, I believe we’re now entering a period where investors need active management.

Until recently, the time was right to own the benchmark. Share markets were driven by the actions of central banks globally printing money and leaving interest rate setting at their most accommodative. Correlations between shares and sectors were unusually high as the market’s momentum trumped anything related to earnings.

There was a change between 2016 and 2017. Calendar 2016 was tough for active managers, driven primarily by the risk-on and risk-off market environment (examples being China RMB devaluation, capital control and Brexit) rather than company fundamentals. This changed in 2017 where companies that grew their earnings were rewarded. You can see this in the average stock’s pair-wise correlation (that is, correlations between different pairs of stocks) which returned to a normal level in 2017 in comparison to 2016 where it was elevated.

In 2018, with inflation back on the horizon and with many tipping four rate hikes this year from the US Federal Reserve, investors should think about what outcome they are investing for, and which managers are best placed to deliver it.

I am not suggesting we stop the discussion on active versus passive. I am suggesting we change the debate on performance, slowly and surely, to talk about what’s really important for clients. As fund managers, we need to take responsibility for this and as a collective talk more about whether our products are meeting client goals, not just beating a benchmark.


Sean Henaghan is Chief Investment Officer and Director of the Multi Asset Group at AMP Capital, a sponsor of Cuffelinks.

March 05, 2018

A lot of the funds industry is similar to the taxi industry, not providing what consumers want, uber highlights what happens when industry sectors treat consumers with contempt....!

Jerome Lander
March 04, 2018

I totally agree that the industry still needs to focus more on client goals and produce products and services which are more aligned with what clients actually want and need. Unfortunately, after decades of the industry emphasizing the opposite, there are very few of us who have significant experience and a proven track record managing to outcome based goals successfully, and in particular managing to a concept of "absolute risk", rather than "relative risk". Perhaps it is unrealistic to expect managers who have always managed in a relative way (often within a specific asset class), to suddenly become effective managers of "client outcomes" and to manage downside risk effectively, particularly if they are incentivised to do otherwise. Those with advisory and consulting backgrounds generally have a better appreciation of client needs, but sometimes need more investment expertise or resources to manage portfolios effectively. Fortunately, there are now more options for advisers and investors looking for genuinely outcome based products, services and advisers, with advisers such as Matthew Walker taking leadership roles in this regard with their own clients and showing the industry that it can be done, along with leading the financial advisory space in this regard through organisations such as the Association of Goals Based Advice.

Scott Tully
March 02, 2018

Well said Sean. The idea that investors have to choose between either active or passive misses the point that portfolio construction is about combining a range of investment strategies that aim to deliver particular outcomes in aggregate. Expected return, volatility and cost are all inputs to that process.

March 01, 2018

This is perhaps a cynical view but should we be surprised to see an active fund manager downplaying benchmarks after a period in which they've been beaten by the index funds on an after fee basis? The writer mentions alpha but provides no evidence that alpha can be produced in a consistent and risk-adjusted way . Sounds like you are saying "If you can't beat the benchmark, don't menton it - or eventually swap it with one you think can beat."

Matthew Walker
March 01, 2018

Excellent article. Thank you for your refreshing comments on what I agree should be the focus for our industry.


Leave a Comment:



The fascinating bank hybrid journey of the last year

Three fascinating lessons overlooked by investors

What now for SMSFs and hybrids?


Most viewed in recent weeks

Lessons when a fund manager of the year is down 25%

Every successful fund manager suffers periods of underperformance, and investors who jump from fund to fund chasing results are likely to do badly. Selecting a manager is a long-term decision but what else?

2022 election survey results: disillusion and disappointment

In almost 1,000 responses, our readers differ in voting intentions versus polling of the general population, but they have little doubt who will win and there is widespread disappointment with our politics.

Welcome to Firstlinks Election Edition 458

At around 10.30pm on Saturday night, Scott Morrison called Anthony Albanese to concede defeat in the 2022 election. As voting continued the next day, it became likely that Labor would reach the magic number of 76 seats to form a majority government.   

  • 19 May 2022

Betting markets as election predictors

Believe it or not, betting agencies are in the business of making money, not predicting outcomes. Is there anything we can learn from the current odds on the election results?

Keep mandatory super pension drawdowns halved

The Transfer Balance Cap limits the tax concessions available in super pension funds, removing the need for large, compulsory drawdowns. Plus there are no requirements to draw money out of an accumulation fund.

Welcome to Firstlinks Edition 455 with weekend update

The resolve of many investors to focus on the long term with their share portfolios is increasingly tested as the list of negatives lengthens. There is a lack of visionary policies during an election campaign and stimulatory spending is contradicting the aims of tighter monetary policy.

  • 28 April 2022

Latest Updates

In praise of our unique democracy and its sausage

For all the shortcomings of our political campaigns, our election process is the best. We are blessed with honest administrators and procedures that we all trust to hand over power peacefully, with a big snag. 

Investment strategies

Is the investing landscape really different this time?

Many market analysts argue that the pandemic has changed everything but we must judge whether the circumstances are as drastic as billed. A quick review of four major events helps decide if this time is different.


Comparing generations and the nine dimensions of our well-being

Using the nine dimensions of well-being used by the OECD, and dividing Australians into Baby Boomers, Generation Xers or Millennials, it is surprisingly easy to identify the winners and losers for most dimensions.


When will I retire? Economic impact of an ageing population

About 39% of the labour force is aged over 45. Intergenerational reports highlight the challenges of an ageing population and the impacts on consumption patterns, dependencies, public finances and economic growth.

The real story behind the crypto crash

The recent sell-off in the crypto market and its trigger - the collapse of the Terra UST coin - has affected many institutions either holding or trading crypto assets, including crypto fund managers.

Investment strategies

Cash is the nightingale, the bird in the hand

The bird in the hand is worth two in the bush, and it's an apt metaphor for investment choices. In 2021, as investors hunted in the bush for decent returns, demand overwhelmed supply. Cash is the bird in the hand.


Book review of 'Putin’s People' and his motivation for war

Author Catherine Belton argues Putin’s sole ambition is to hold onto power. Her book seeks to understand why Putin invaded Ukraine after he became isolated and out of touch with reality during the pandemic.



© 2022 Morningstar, Inc. All rights reserved.

The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.