Active vs Passive - The Debate Continues

I often come across two sets of people.

The first is a die-hard investor whose thinking is rooted in trusting and relying on the market and simply riding the wave.

The other kind of investor, however, is someone who does not trust the market and will almost always take a chance on finding winners.

For those in the market, this active vs. passive investing debate is not new. I think it has been brought into conversation every time a fleet of new investors joins the market. And it will keep being recycled again in the future as well. What is to note are the fundamentals of it all.

Passive Investing

This is low-cost and low-effort, and historically, broad market indices tend to outperform most active managers over the long run. Passive investors often think (and for good reason) that the S&P 500 doesn’t get emotional or make mistakes—it just compounds.

In India, Gold is easily the most obvious passive investment that families have made for generations. Those who invested in gold in the early 1970s did so around the rate of ₹200 per 10 gms. We all know what the rate of gold is today. Imagine the returns. Now imagine that there are some people who still won’t sell the gold they bought in the 1970s. Still. This is the kind of long, futuristic game that’s played with passive investing. Although, word to the wise, knowing when to cash in is also something you need to be cognisant of.

Passive investing does not come without limitations. While you enjoy when the market rises, you are also fully exposed to market downturns. You can’t actively manage risk or pivot during volatile times. Also, you will not be able to capitalise on opportunities presented in upcoming and niche sectors.

Active Investing

A well-executed active investing strategy involves identifying undervalued opportunities and hedging against downturns that can result in even beating the market. However, this is possible only with a lot of skill, knowledge, patience, and discipline.

One of the most famous examples of this is that of a legendary investor’s Titan Bet. He invested in Titan when the stock was priced around ₹3 in the 2000s. He has over 4.4 crore shares of Titan. Today, Titan’s price is upwards of ₹3,000 per share. Calculate this massive amount for yourself. Or just google it.

The risk with active investing is almost always as great as the reward itself. Plus, it’s incredibly difficult to sustain. Not a lot of active managers possess the patience and discipline required for active investing. This could be, at times, a ‘market against person’ situation. When the person wins, they can win big. But the loss can be equally devastating.

So, what to go ahead with?

A lot of people will say this and I concur that this is not an either-or situation.

Passive investments will give you stability based on historically evident market performance at low cost. Mostly index investors, large cap (which are well researched and information is more widely available and tracked) investors or those just looking for an asset class exposure (ie. Foreign investors/pension/Insurance etc.) tend to look at passive investment opportunities (i.e. ETFs and Index Investing).

Active investments will give you the flexibility to research and invest on something to give yourself a chance for alpha generation. As it is, usually under-researched value stocks (mostly mid and small caps) provide higher opportunity for alpha generation, as and when the value unlocks and the company is more widely recognized for its strengths.

As it is in life, you need stability but you also need freedom and that is how the case of passive and active investments is. You just need to decide what you need more at any given point in time and then go for it. And you may not always have to choose one against the other- sometimes a judicious mix of Active and Passive may give you the best portfolio mix!