Avoid arbitrary investment decisions: Vanguard
Investors need to avoid arbitrary action when deciding how to allocate their portfolios across actively managed and index investments and follow clear process strategies, according to Vanguard.
Vanguard’s new white paper ‘Making the implicit explicit: A framework for the active-passive decision,’ has outlined a decision-making framework of four variables for strategising around asset allocation across active and index strategies.
Vanguard Australia head of investment strategy, Aidan Geysen said the framework had been developed by the group’s Investment Strategy Group and considered the following four variables for decision-making:
- Gross alpha expectation: the expected outperformance of a given active strategy
- Cost of active management: management expenses, transaction fees and other costs associated
- Active risk: the potential for underperformance by a given active strategy
- Risk tolerance: an investor's tolerance for an active manager's potential underperformance
Geysen said the report highlighted the importance of establishing an appropriate strategic asset allocation from the onset of the construction process and taking into account the unique needs of a portfolio.
“Discussions about active and index investing can draw some strong views from investors and their professional advisers, one way or the other,” Geysen said.
“We see active-passive not as a debate, but as an asset allocation decision, and this framework gives investors a clear process to help them determine the active and index allocations within their portfolio.”
Investors’ preference for risk, their return requirements, goals and investment horizon were also measured within the research, which Geysen said had been designed to assist investors to think more carefully around expectations and risk.
The report also said the four variables could also assist investors to decide whether to implement index or active, or a combination of both in discussion with an adviser.
“Choosing between active and index isn't a philosophical decision – it's part of the asset allocation process. The ideal choice is the one that best aligns with an investor,” Geysen said.
“Whether or not a higher allocation to active is appropriate can differ greatly.”
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