The COVID-19 crisis has created changes in investing that are likely to stay. One such pioneering change has been the swift shift among investors towards passive investing.
As the name suggests, passive investing includes investing in funds that are not actively managed but instead linked to a benchmark index. This investing style calls for a long-term involvement in Exchange traded funds (ETFs) or index funds.
Over the course of the coronavirus pandemic, investments in ETFs and index-based funds have outperformed the investments in actively managed funds.
Interestingly, the Australian markets also resonated with this trend, with a larger share of investments poured in the passively managed funds in recent months.
Not only has this trend garnered investors’ attention across the globe but also touched the pleasant chord of world’s renowned business magnate, Warren Buffet.
Why has passive investing captivated investors?
The magnitude of disruption by COVID-19 have set the stage for a shift in investment cycles.
Passive investing gained prominence amid inflows into the cheap, index-tracking share funds as equity markets around the world rebounded to record high levels over the past year.
Features of passive investing like its low-cost advantage and relatively lower level of knowledge required to enter the market, appear to have lured investors towards index funds.
Unlike active investing, investors need not be well versed with the stock market before taking the plunge. Tying their investments to market indices allows investors to easily tap the performance of their funds by gauging the performance of the benchmark.
Meanwhile, strong corporate growth seems to have spawned the strength observed in the equity markets over the past few months, making the case stronger for benchmarked funds.
As countries are gradually emerging from the ravages of the pandemic, companies are in the process of observing profitable quarters.
In order to tap significant returns from the economic recovery, investors are considering participating in the upward trajectory of corporate profits via major stock market indices.
Standout features of passive investing
Passive investing features make it a unique tool for investors who are new to the market or seasoned in their field like the tax-deferred cash returns offered by passive investing.
This aspect provides it an edge over other forms of returns such as dividend payments that can be taxed heavily. Another striking aspect is that passive investing allows individuals to leverage the financial wisdom of other players in the market.
While solo investors may have the liberty to choose their investments, not everyone possess the required financial knowledge to play solo in the market.
Passive investing acts as a mediator between banks and investors. Sometimes, approaching banks for financing may not be a viable option for borrowers due to extensive paperwork.
Investment companies providing passive funds have pre-existing relationships with banks. Thus, the burden of financing an investment can be slightly eased with passive investing.
Passive investing turns an individual into an equity holder. Individuals who are apprehensive to invest can simply depend on an index fund to sort out their investments for them.
Is passive investing better than active investing?
Given the pocket-friendly aspect of passive investing, investors may utilise this investing technique often to build their investment portfolio.
In fact, passive investing creates room for investors to find undervalued equities before everyone else, allowing them to access a broader set of opportunities in the market.
In active investing, fund managers are as prone to missing out on a great opportunity as any individual in the market. Fund managers can only outsmart other investors for a limited time, and consistently reaping the market returns is not possible either.
Paying a fee to expose oneself to the possibility of loss seems futile to some investors against lower-priced passive investing. Passive investing does not aim to beat the market.
It involves putting one’s money into the index’s stocks in the same proportion as they comprise the index. Hence, the focus gets shifted to the market index and its movements.
Investors who invest in index funds for a long run usually tend to enjoy a larger share of profits brought by company-issued stocks. In the current scenario, it will be enticing to see how investors change their palette for investing as the economies recover from the virus crisis.
In case the appetite for risk increases among investors in the post-COVID environment, the market may see investors deflecting to other perilous forms of investment. However, it will be no surprise if passive investing sticks out as a long-term trend.
Mr. Kunal Sawhney, the Founder and CEO, Kalkine Group is a richly experienced and accomplished financial professional with a wealth of knowledge in the Australian Equities Market.