Passive Investments

A broad and varied array of passive investments are available via the Novia platform. These range from tracker funds managed by a number of large and well known investment houses and smaller boutiques to Exchange Traded Funds (ETFs) from some of the world's biggest providers. These investments can play an important role for both adviser and client when constructing an investment strategy and portfolio to suit a range of individual profiles.

Using passive investments can have great benefits but is by no means the only option available - so what is passive investing and what are the potential pros and cons?

Q / What are Passive Investments and what is the theory behind them?

A / Passive investments such as tracker funds or ETFs aim to deliver market returns - they follow or 'track' an index or sector and seek to provide the same level of performance as that market. Management of the fund is based on holding the same investments in the same proportions as the underlying index or sector - therefore providing matched performance.

This is known as passive management - for example a passive fund may be a FTSE 100 Tracker - the fund will be made up of the FTSE 100 constituents and will generate similar returns. Any, usually small, deviation in performance from the underlying index is known as 'tracking error' and this is one way to judge the performance of a passive manager.

Q / What's the theory behind passive management?

A / Passive management's theoretical basis is that it is difficult or impossible to outperform the market, ie that the market is always efficiently priced. Therefore it is not possible for active managers to consistently deliver increased returns over and above that of the market. It can therefore be argued that it is better to select funds that closely track different markets and use asset allocation analysis to select which of these markets and in what proportions a portfolio should follow. Model Portfolio Theory argues that asset allocation and not fund selection is the major determinant of risk adjusted performance.

Q / How does passive management differ from active management?

A / Whilst passive management seeks to provide the same returns as an underlying market active managers seek to outperform the market and deliver excess returns. These excess risk adjusted returns, over and above the market return are known as alpha, and this measure is a key way to judge an actively managed investment. Active management is based on the belief that the impact of an informed and talented investment manager with skills in stock selection and market timing can deliver returns.

Q / How can I evaluate the performance of a passive manager?

A / Clearly the impact a passive manager can have on performance is limited and cannot be judged in a similar fashion to active managers. The job of the manager is to track the underlying index as closely and efficiently as possible - delivering the same level of performance as the chosen benchmark. Tracking error, a measure of how well the underlying index is replicated provides a way to judge the performance of a passive manager. All of the passive investments available through Novia can be evaluated using the research tools made available through the service.

Q / What can Novia offer?

A / Please see the Investments List for full details of the investments available through the service.

  • Tracker Funds

Through Novia you can utilise a broad range of tracker funds, often with access at very low cost, covering numerous markets and indices across different asset classes and regions of the world.

These are unit trusts or OEICs which hold stocks matching an equity, bond or property index, usually with no initial charge and low annual management charges typically ranging from 0.20% to 0.90%.

We offer passively managed funds from many providers, including for example Vanguard, L&G, HSBC and M&G.

  • Exchange Traded Funds (ETFs)

Novia offers access to a very large number of ETFs from many major providers. These are stock exchange traded funds which track a vast array of indices and markets around the world. They are usually low cost with annual management charges typically ranging from 0.25% to 1%.

ETFs from providers such as BlackRock iShares, ETF Securities and DB x-trackers can be traded on an aggregated basis through the Novia platform or the wide range of sterling denominated ETFs on the LSE can be traded via a Novia Stockbroker account.

Charges for the trading of ETFs will apply, details of which are available in the Key Features document.

Q / What are the pros and cons of passive investing?

A /  To an extent the answer to this depends on your view of passive v active investment. Novia does not offer advice but makes both active and passive investments available.

  • If you believe that active managers cannot consistently outperform the market, the cost does not equal any added value and asset allocation is more important you may choose to use passive investments for some or all of a portfolio.
  • If you do believe that active managers can justify the cost through added excess return then the vast array of actively managed funds are available. It is also possible to argue that the selection of managers is the key point here and that the best can indeed outperform consistently.
  • Many advisers may choose to use a mix of active and passive investments, often through an approach known as 'core and satellite' or 'hub and spoke investment'

Q / What is a core and satellite strategy?

A / This is an investment strategy that involves a core element of usually passively managed investments covering the selected risk appropriate asset allocation and a percentage of selected individual investments known as satellites. These may be actively managed investments to provide extra added return or to cover specific markets or trends required.

The core typically constitutes the major part of the portfolio, normally 60% to 80% and would remain relatively static.  The number of Satellite investments can be whatever the client is comfortable with and would be more actively managed.  They may be changed more frequently than the core investments as they would be used to time the market or exploit short term anomalies or trends.

The satellite investments are typically concentrated, actively managed funds with no particular benchmark to track but focussing on delivering high returns, however, they can also be passive funds, ETFs or individual shares used to 'tilt' the core to a particular sector, region, style etc.  Satellite investments are usually higher risk and have higher fees than typical actively managed but broadly based funds.

The jargon often used is that the core is delivering Beta return whilst the satellite investments may generate additional Alpha returns. Beta provides a measure of how an investment follows and delivers the risk/return profile of the wider market.