Active investing is back. Young investors are all over it. Instead of quietly sticking their money into passive index-tracking exchange-traded funds (ETFs), they are noisily diving into meme stocks, technology titans and cryptocurrencies, looking for a fast return and a quick thrill along the way.
Few investment experts predicted that. Passive investing has dominated for the past decade or two and most thought the argument had been won in favour of the index trackers.
Blame Tesla and Elon Musk, if you like. Blame the pandemic. Most of all, blame those pesky millennials, who once again seem to be going their own curious way and dragging Gen Z along for the ride.
Simply sticking money into a no-frills, low-cost ETF and leaving it go grow for 30 or 40 years isn’t rewarding enough for younger investors, either financially or emotionally. As incomes flatline, they want their investments to shoot to the stars.
They want to smash the market, bring down the fiat currency system and destroy greedy Wall Street hedge fund managers, while they’re at it.
Like all investors, they want to make money, too. It may be the only way they can get on the property ladder.
The new breed of hyperactive investors does not care that passive fund investing is cheaper and more rewarding in the long run.
They ignore survey after survey showing the majority of active fund managers underperform their chosen benchmark index.
Only one in four active managers beat their benchmark over the 10 years to June 2021, despite all the tools and experience at their disposal, according to analysis of nearly 3,000 funds by Morningstar.
Active managers operating in the world’s biggest market – US large caps – fared worst of all, with just 11 per cent beating passive trackers.
If they can’t make a go of active trading, with all the tools and experience at their disposal, what chance do millennials and Gen Z have?
It won’t stop them, though. They’ve got a taste for active trading, at least, until their losses start racking up and that property slips further out of reach.
The active investing revival can be traced back to the Covid-19 lockdown when people got bored but couldn’t gamble on cancelled sporting events, so they switched to trading volatile stock markets instead, Nick Wood, head of fund research at Quilter Cheviot, says.
When government stimulus cheques hit their bank accounts, they traded that money, as well. Hence all the craziness surrounding meme stocks like AMC Entertainment and GameStop.
This influx of enthusiastic, short-termist amateurs may have played into the hands of professional fund managers with developed, far-sighted strategies, Mr Wood says.
“In China’s domestic onshore market, where retail investors make up around 80 per cent of trading volume, active managers are more likely to outperform their benchmark.”
Today’s bout of volatility, triggered by inflation fears and the Omicron variant, also favours active trading, Mr Wood says, but warns that investors must be prepared to suffer periods of underperformance and should only invest with a long-term view.
It is hardly surprising that newbie investors favour active trading as the rewards seem so much greater, David Jones, chief market strategist at Capital.com, says.
“In January, GameStop shot up more than 20-fold in a matter of weeks. After witnessing that, it’s harder to be impressed by the 20 per cent year-to-date return from the SPDR S&P500 ETF, even though that’s excellent by most standards.”
The same mentality took hold in the frenetic dotcom boom of the late 1990s, he adds. “Triple-digit percentage gains in hot stocks trounced traditional funds.”
That didn’t end well and investors face similar risks today. “For every GameStop, there are tens of individual stocks that will bomb and leave investors licking their wounds,” Mr Jones says.
He suggests putting the majority of your long-term investment portfolio into passive trackers, while allocating a smaller portion to chasing the next big thing.
Active investors may get a reality check as their losses rack up, Jason Hollands, managing director of Tilney Investment Management Services, says.
Some will have an inflated idea of their abilities after the “incredible” bull market off the last dozen years, he adds.
“When most stocks are rising, it is easy to assume you are a great stock picker. You may get a reality check when markets fall.”
Today’s bull run has also flattered passive fund performance and ETFs will inevitably crash when stock markets do.
Another danger is that ETFs leave investors exposed to valuation bubbles, Mr Hollands says, as they have a habit of sucking cash into big, successful companies, irrespective of whether their shares are still good value.
Mr Hollands tips a new breed of ETFs dubbed “smart beta” passives or “factor funds”. “They don’t just invest in the biggest stocks, but also rank constituent companies by the strength of their balance sheets, profitability, dividends or value,” he says.
As with a traditional tracker, there is no manager and fees are low, but you get more control over the type of business you invest in, Mr Hollands says.
Active traders rack up more trading fees than passive ones, which eat into returns, Chaddy Kirbaj, vice director at Swissquote Bank in Dubai, says. “Passive investing involves less buying and selling, which leads to lower costs and more predictable returns.”
Another advantage of passive investing is that it does not require sophisticated expertise, he adds.
So, the decision partly depends on you. Are you an active day trader who likes to take risks in the hope of generating higher returns? Or would you rather let your money go to work quietly and grow over time without having to worry about it too much?
The best solution is to use both strategies, Rob Burgeman, senior investment manager at Brewin Dolphin, says.
You could adjust your exposure to each technique, depending on market conditions. “When volatility is low and markets are rising, you might as well invest in a tracker because share prices increase indiscriminately. However, when markets are in flux, active strategies are more likely to outperform.”
Some countries or sectors offer more fertile ground for active investors and fund managers, Mr Burgeman says.
“Historically, the US has not been great for active managers. Given the difficulty of beating the S&P500 index, it is better to simply buy an ETF tracker,” he adds.
Europe has more diverse markets, with a huge difference between, say, Spain and Sweden, which allows managers to seek out opportunities and add value. Active managers also fare well in Asia and Japan, he adds. Small and medium-sized companies offer more active investment opportunities than larger ones, as specialist managers can unearth hidden gems at an early stage.
It is hardly surprising that millennials and Gen Z are getting active and even harder to criticise, Vijay Valecha, chief investment officer at Century Financial in Dubai, says. “They are young and relish the excitement and challenge of frequent trading and find passive investing a bit safe and boring.”
They should still beware of hopping on bandwagons and chasing yesterday’s trends, “whether that’s meme stocks, a skyrocketing crypto like dogecoin, or pandemic-related exercise fads”, Mr Valecha cautions.
Younger investors should not be too sniffy about passive investing, though. “It is cheaper, requires little research and upkeep and you will almost always beat active fund managers over periods of 10 or 20 years, due to lower charges and greater consistency,” he says.
Those who thought the active/passive debate was settled as ETFs became dominant were premature. It is back with a vengeance, and a good thing, too.
“Skilful active trading may even have the edge over passive investing in the short term, and it’s great that younger investors are taking an interest,” Mr Valecha says.
The problem is that beating the market by active trading is not so easy. If it was, older investors would be doing it, too.