It's a farmers market

When asked about the debate between active and passive investments, we observe a striking semblance between the rise of both passive investing and industrial farming.

There was a time, not long ago, when all fund managers were active stock-pickers. Similarly, even longer ago, traditional farming methods dominated agriculture. The farmer would manually cultivate his land with love, care and attention to detail.

Then one day, to the farmer’s shock, an enormous harvester arrived in the neighbour’s field. The nature of agriculture was changing; mass production and machines leading to lower costs.

With machines cutting costs and driving down the price of agricultural output, what was the traditional farmer to do? They continued to focus on high quality, organic, locally produced food. They knew that quality and experience was worth paying for.

Take tomatoes – so often you can see and feel the difference of mass production long before you experience the (rather bland) taste. Compare that with the big red, ripe and tasty tomatoes grown on an organic farm. Yes, they may be a bit more expensive, but that difference in quality is often well worth paying for.

Some recipes better suit the great taste that organic ingredients can provide. Cheap tomatoes are great to make ketchup, but surely not for your prized family arrabiata?

Red sky in the morning

Years of experience enhances seasoned judgement. A farmer may look to the sky and sense frost is on the way. What does that mean for the crop? Should they cover the tomatoes or is it a false signal?

Likewise, a seasoned investor may see disruptive conditions on the horizon; is it time to “cover the tomatoes”? A move from more cyclical to more defensive stocks may be in order. It’s when conditions get tough and more difficult to read that experience and proactivity often pays off.

Having the ability to deviate from an index allows us to be nimble and capture opportunities the wider market is yet to spot, or hunker down to ride-out possible storms. With geopolitical concerns continuing to play on investor sentiment, could erratic weather once again be on the horizon?

A serving of both

As with farming, it would be counterproductive to dig our heels in and refuse to recognise the strengths of both active and passive investing. We have to move with the times, and harness the resources that allow us to perform our job to the best of our abilities. That’s why we integrate strengths from both styles, complimenting fundamental research with a more systematic, quantitative management approach to help prevent natural biases and the inherent fallibility of the human psyche that tempts us to buy high and sell low.

Crucially, we have to recognise where we may not have an edge, such as certain Emerging Markets – if we can’t add value above and beyond the markets, then a passive investment is often a good solution.

Ultimately, it’s up to advisers to decide what kind of “tomato” is suitable for each client. Just as there is a place for both organic and industrial farming in modern society, so too is there a place for both active and passive investment styles and the two need not be mutually exclusive.

After all, lift the bun off your burger and you’ll likely see both a juicy slice of tomato and a generous dollop of ketchup. Both have their part to play!

All investments carry risk. The value of your investments can go down and up and you may get back less than you originally invested.