In recent years, more and more equity investors have shifted toward passive investment strategies. Rather than actively selecting individual stocks, passive funds typically invest in assets that track stock indexes, offering returns that mirror the broader market—both the highs and lows.
However, while passive strategies are popular, active strategies can often deliver better returns, especially in stock trading and real estate investments.
According to Morningstar, mutual funds and exchange-traded funds (ETFs) following passive, index-based strategies manage an astounding $6.8 trillion in assets, a significant increase from $2.7 trillion in 2013. Currently, around a third of U.S. assets are managed with passive strategies, and this proportion continues to grow as more investors move their funds away from actively managed portfolios.
In response, many active fund managers have adapted to the growing demand for passive strategies by introducing equity funds based on “focused strategies,” which involve holding fewer than 50 stocks. A survey by Greenwich Associates and Fred Alger Management Inc. found that over half of 91 institutional investors had increased their allocations to focused-strategy funds within the past 18 months.
The appeal of these focused strategies is that they typically feature stocks that the fund manager believes have the most potential. A fund with fewer than 50 stocks is less likely to track the performance of a broad stock index, offering the potential for higher returns.
According to Jim Tambone, Chief Distribution Officer at Fred Alger Management, focused strategies may outperform passive strategies because the probability of beating the market is higher with a smaller pool of stocks. He explains, “With 10 stocks, you have much greater potential to outperform the market compared to 1,000 stocks, because once you reach 1,000, you’re essentially mirroring the market itself.”
Active strategies also have their advantages in real estate investments. For example, when it comes to purchasing and renovating rental properties, the choice between a passive or active strategy depends on the investor’s goals.
A passive real estate investor is a limited partner who has little control over the project’s business plan, relying heavily on the sponsor to execute the plan. To reduce risk, passive investors can negotiate for a “preferred return,” ensuring they receive a set return before the sponsor gets paid.
On the other hand, active investors have direct control over decisions such as property acquisition, renovation plans, tenant selection, rental pricing, and the timing of refinancing or selling the property. While active investors take on more risk and a greater time commitment, they also have the potential for higher rewards. The most common mistakes active real estate investors make include underestimating renovation costs and overestimating rental income.
Ultimately, while both strategies have their merits, active investors who assume full control of their investments may benefit from higher returns and a greater share of profits compared to passive investors who rely on others to manage their investments.
