A core of passive investments alongside a few well-chosen active funds can help you achieve the elusive balance between stability and growth. Take a look at how this ‘core and satellite’ investment strategy works and see whether it might be right for you…
Striking a balance: active and passive investments
What are active and passive funds?
Active funds are so named because a fund manager takes an ‘active’ hands-on role in making investment decisions. With active funds, the fund manager is continuously researching companies or other investments to look for growth potential. They may buy and sell assets frequently in the hope of earning returns that beat their market sector.
Passively managed funds take a different approach. Instead of trying to beat a particular market or sector, they aim to follow it as closely as possible. The majority of passive funds are index-trackers. These funds aim to replicate a particular market index, for example the FTSE 100 Index.
Benefits of passive investing
Passive funds tend to have lower management costs than actively managed funds because they don’t require a large research and management team to run them. Index-trackers usually offer another key advantage - diversification as funds may hold shares from hundreds of different companies. Active funds, in contrast, typically hold a smaller number of assets, so the impact of any one company underperforming could be greater.
What do active funds bring to the table?
In certain markets, studying wider economic trends and analysing the market can reveal short-term investment opportunities. They can also potentially provide access to asset classes difficult to access from passive funds.
In addition, active funds generally take on more risk than passive funds, giving you the potential for higher returns. However, you’ll need to be able to take a longer term view, to wait out the inevitable down cycles. But as with all investments, returns are not guaranteed and you could end up with less than you invested.
Combining active and passive funds
Many investors adopt a core and satellite (or ‘core and explore’) strategy when it comes to active and passive funds.
With this approach, the majority of your investment portfolio is placed in passive index-trackers to help create a stable core. From there, smaller amounts are allocated to your satellites – a few carefully selected active funds designed to help your portfolio beat the market.
Why adopt a core and satellite approach
While a core and satellite strategy isn’t for everyone, it’s appealing to investors looking for a low-maintenance portfolio designed to give a balance of stability and growth.
A large core of passive index-trackers helps give you:
- Diversification - with just a handful of index-tracking funds you can get exposure to a wide range of asset classes, investment styles, industry sectors and geographic areas.
- Lower costs - can result in better performance, as fees have a significant impact on returns over time.
The main reason for adding active funds as your satellite holdings is to try and generate market-beating growth. Which is why this approach of adding a small portion of active funds to a largely passive portfolio is favoured by some investors.
Keep in mind that this style of investing works best as a medium or long-term strategy.
- Please remember the recommended medium to long-term investment period is ideally five years or more.
- The value of an investment and any income from it may fall as well as rise and is not guaranteed and you may get back less than you invest.