By Business & Finance 
Investment decisions are complex, with numerous choices to be made, particularly when deciding if an active or passive investment approach is best, writes Shane Quinn.
Investment decisions are complex, with numerous choices and options available for investors. The turmoil across investment markets during the recession caused investors to question whether to take an active or passive investment approach with regard to asset allocation.
Passive management argues that markets are efficient and that tactical investment decisions on a regular basis will not result in out-performance. Passive investment managers do not attempt to time the market. The investment split changes in line with the market benchmark. The majority of passive funds are index funds which mirror an index; they offer lower charges; performance is close to the benchmark; and there is no manager selection risk.
Active management on the other hand has many strategies that allow it the opportunity to outperform the market − from timing the market; holding cash positions; going overweight or underweight on certain stocks or sectors; taking a view on a certain economy and using top down bottom up approaches to investment philosophies. Essentially, active asset managers can change their asset allocation to generate returns in excess of the market. Management charges are usually higher in active than passive funds but active managers argue that this more than compensates for the return achieved.
Long-term returns
As equities have an element of risk, the return that really matters is real return (adjusted for inflation) as opposed to nominal return. Equity risk premium is the additional return for bearing risk on equities. It is measured as the returns on equities less the return on bonds. Equity Risk Premium (ERP) has been positive in the long-term and there is confidence that it will continue to be positive, albeit not as high due to falling interest rates and bond returns.
Strategic Asset Allocation (SAA) is a mix of investment asset classes held strategically which are best placed to meet client objectives by delivering on investment returns. The SAA can change over time depending on the client’s needs. Whether active or passive investment approaches are taken, SAA is key to determining long-term returns.
Commodities
One of the main reasons why alternatives such as commodities and gold are used as part of a portfolio is due to the low correlation (they react in different ways to equities) and diversification benefits offering lower level risk for a given level of return. However, during the recent crises the correlation changed and therefore raised questions about the value of alternatives as part of a diversified portfolio’s future potential.
Whether active or passive investment approaches are taken, SAA is key to determining long-term returns.”
From an Irish perspective, another asset class of note is property. Property is often regarded as a sub asset class in a portion of a portfolio − ideally with a small weighting. Property as an asset class has attributes similar to equities. It takes a long-term view and it is linked to the performance of the economy, as an asset class it is risky with a level of volatility similar to equities. However, over the last 40 years, property has underperformed equities but the value of property as part of a portfolio is diversification and low volatility and correlation with equities.
The nirvana is that as uncorrelated assets become more correlated you need to have uncorrelated assets that stay uncorrelated in a crisis. However, irrespective of choosing an active or a passive investment approach, the greater decision point will continue to be SAA as the main contributing factor to portfolio performance.
