Part 4 of 4

Advisors should consider using a combination of actively and passively managed investment products when designing portfolios for their clients, according to portfolio manager Richard Croft.

Speaking at a conference organized by Advocis in Toronto on Friday, Croft, president of R.N. Croft Financial Group Inc., outlined both sides of the ‘passive versus active’ investing debate.

In terms of active management, he pointed to such advantages as expert analysis and the possibility of returns that beat the index. Exchange-traded funds, on the other hand, offer such advantages as lower fees and more flexibility in terms of asset allocation.

Croft encourages advisors to capitalize on the advantages of both types of investments by incorporating them both into clients’ portfolios.

“A core-satellite strategy that explicitly combines active and passive investing,” he said, “is a very powerful tool that advisors employ to strike a balance for their clients.”

This strategy involves using passive investments as a core part of the portfolio, surrounded by actively managed products that seek to add an element of alpha. He noted that this investment model is used for the Canada Pension Plan.

“Maybe if it works there, and maybe if pretty much every pension plan in Canada operates under the same model, maybe that’s the right approach for all of us to take for our clients,” Croft said.

In using this model, he said it’s crucial to have a strong long-term core that doesn’t need regular adjusting. For example, he suggests using a number of broad-based, passive ETFs.

“Without that, you’ll never be able to keep up with all of the changes that are going on in the landscape today,” he said, explaining that new, innovative investment products continue to emerge in vast quantities.

The ‘satellite’ portion of the portfolio can incorporate more specific investment styles and trends that seek to generate higher than index returns.

Croft warned advisors that using passive investment products involves much more work in terms of allocating assets. Advisors must determine what types of ETFs to use and which sectors to invest in. Many advisors might not consider this an effective use of their time, he said.

“If your practice is managing a relationship with a client, maybe you don’t want to worry about the asset mix and the rebalancing of a portfolio and all of the issues that go with that,” Croft said.

But on the other hand, he said some advisors enjoy having more flexibility and control over the asset allocation in their clients’ portfolios.

When discussing the passive versus active debate with clients, Croft said it’s important to remind them that fees are not the only consideration.

“You need to remind them that you are focusing on being able to deliver something to them that will take fees off the table to give them the kind of portfolio they need,” he said.

IE