Their strategic asset allocation and stock-specific investment decisions allow them to add Alpha – or value above the momentum of the assets in their portfolio.
Proponents of passive investing take the opposite view – believing that human influence cannot consistently outperform average benchmark returns over the long-term.
This is known as the efficient-market hypothesis – or belief that financial markets, such as the FTSE, are accurately valued and will continually correct themselves if returns start to swing wildly on investor sentiment.
As a result, passive investments seek to "track" an index and tend to mirror the composition of their benchmark, the FTSE 100 for example.
The advantage of passive funds is that they tend to be cheaper than their actively managed counterparts, with charges ranging from as little as 0.1 per cent to nearly 1 per cent.
The $9.3bn iShares Gold Trust, for example, carries an annual management charge (AMC) of 0.4 per cent and its total expense ratio (TER) is the same.
By comparison, the £2.8bn BlackRock Gold & General fund has an AMC of 1.75 per cent and a total expense ratio of 1.94 per cent, according to FE Analytics.
The portfolio has returned 26.4 per cent over five years, significantly outperforming the FTSE 350 Mining index, which sustained a loss of 10.61 per cent over the period.
However, the five crown-rated ETF has smashed the performance of both the unit trust and the Global ETF Commodity and Energy sector over this time, returning 181.08 per cent, while the sector has returned 29.03 per cent.
Performance of ETF vs fund and indices over 5-yrs
Source: FE Analytics
In a previous article, Rob Gleeson, head of research at FE, said trackers will often outperform actively managed rivals over the long-term, but he stands firmly in the corner of active management.
Gleeson argues that the diversification benefits active managers provide far outweigh the general outperformance of tracker funds, by lowering a fund’s correlation to its asset class.
Since the credit crisis in 2008, markets have been exceptionally volatile, meaning that indices have gained and lost record amounts – leaving little downside protection for passive investments.
One comfort passive investors can take away is that because the tracker mirrors the composition of the index, they will not have to worry about underperforming the benchmark, but they will miss out on gains above the index on the upside.
Additionally, if markets crash simultaneously, as they did in 2008, investors have to ask themselves if they would rather follow the index, or trust an active manager to dampen volatility and preserve capital.
Passives exist in two forms – either as trackers, which can be bought and sold in the same way as unit trusts, or exchange traded funds (ETFs) which function as shares on the stock market.
The most common focus of passive funds is equities; however, increasing numbers are being launched that aim to harness returns from fixed income and commodities.
Over this weekend, FE Trustnet will examine passive funds and investigate whether they do have an edge over their actively managed rivals.