Investors Miss Much of the Subtlety in ‘Active vs Passive’

Findings from a Natixis survey suggest many investors have expectations that “don’t reflect a full understanding of the risks of index funds versus the benefits.”

More than three-quarters of investors agree that index funds and exchange-traded funds (ETFs) are usually a cheaper way to invest compared with active equity mutual funds, but 71% “also believe they are less risky,” according to new research from Natixis Global Asset Management.

According to Natixis, 64% of investors “think using index funds will help minimize investment losses,” despite the fact that the simple category title of “index fund” says next to nothing about the actual risk characteristics of the investment being considered. Similarly, nearly seven in 10 (69%) investors “believe index funds offer better diversification,” and nearly the same number (61%) believe index funds “provide access to the best investment opportunities in the market.”

Natixis finds many investors expecting lower risk via indexed investments “were surprised at the start of 2016 when the Standard & Poor’s 500 had its worst opening since 1928.” The index bottomed out on February 11, having fallen 10.5% since trading began in January, Natixis explains. “The market did rebound, finishing the quarter 0.7% ahead, but tracking the index would have resulted in a hair-raising ride. And while the first quarter might be seen as an anomaly, volatility in markets is not.”

Taking this all together, Natixis urges financial services providers to ensure their clients understand up front what the real definitive characteristics of “active versus passive” actually are.

“It is critical to understand the risks in your portfolio, so it’s troubling to see investors mistakenly assign benefits to index funds that they don’t actually have,” adds John Hailer, CEO of Natixis Global Asset Management for the Americas and Asia. “Index funds have a place in portfolios, but their low cost seems to be providing a ‘halo effect’ that could blind-side investors during volatile markets. Professional investors see the role for passive investing differently.”

NEXT: Open to new strategies and approaches 

According to Natixis, the survey finds evidence that investors are willing to move beyond 60/40 allocation investment approaches.

“Nearly two-thirds (65%) say a traditional approach (equities and bonds) to portfolio allocation is no longer the best way to pursue returns and manage investments,” the research finds. “Further, 70% of investors want new strategies that are less tied to broad markets and 75% favor strategies that can help them better diversify their portfolio, an approach that would seem to open the door to wider ownership of alternative investments.”

While just over half of investors (52%) surveyed actually own alternative assets—a grouping that includes private equity, long-short funds, hedge funds and real estate—investors who don’t own alternatives say the assets are too risky (56%). Another 34% in this group “acknowledge they don’t understand how alternatives work,” and 28% “don’t think they need alternatives.”

Natixis finds investors say learning more about investing is the number one thing that would help them better achieve their investment objectives. Overall, 68% of investors surveyed by Natixis “avail themselves of some type of advice, with 48% working exclusively with personal financial advisers and 6% using “only automated online services.” Another 14% use a combination of personal and robo-advisers.

“It is encouraging to see investors are looking beyond traditional asset classes to build portfolios designed to help them reach their financial goals through the widest range of potential market conditions,” Hailer concludes. “However, it is clear the financial industry still needs to provide more education to help investors make informed decisions.”

Additional survey findings are presented here