Active vs Passive Funds: How We've Enhanced Your Plan

Tea or coffee? Lie-ins or early starts? Active or passive fixed income investment funds?

Depending on who you ask in our Investment Team, the answers to the first two will be a mixed bag.

Thankfully, the one thing we can all agree on, is active fixed income funds being the way forward for Wealthify Plans.

Whoa, whoa, hold up a second — fixed what?

Fixed income: a type of investment that produces a regular return based on a fixed interest rate and schedule.

A regular return? How does that work?

When you buy a fixed income investment, think of yourself as lending money to organisations – such as governments and corporations – over a set period of time.

In return, they pay you a fixed interest rate once the ‘loan’ period ends (aka matures).

However, this fixed interest rate doesn’t mean a guaranteed return; if, for whatever reason, fund managers sell bonds before they mature, you could get back less than you invested.

Gotcha. And the main examples of fixed income are?

Things like government bonds, government gilts, corporate bonds, and certificates of deposit.

Remind me: what’s the difference between bonds and shares again?

Bonds are investment products created by governments and companies to raise money to pay for big projects. They’re generally considered lower-risk investments than shares, which is when you own a part of a company.

And what about active and passive funds?

So, active funds have managers actively making all the investment decisions, with the overall goal of outperforming the wider financial market.

Passive funds, on the other hand, replicate the performance of the market/index they’re tracking — which is why you’ll also hear them called index or tracker funds.

And Wealthify Plans are moving towards active fixed income funds, right?

That’s right (although the following changes have just been made to Original Plans).

Whereas your Plan’s fixed income government and corporate bonds used to be mixed together, we’ve decided to separate them as part of our long-term strategy.

As a result, we’ve recently added the following actively managed fixed income funds:

• Royal London Corporate Bond
• Royal London Short Dated Corporate Bond
• M&G Short Dated Corporate Bond

To make way for the three new active funds, we’ve removed the following passive ones:

• L&G Short-Duration UK Corporate Bonds
• Vanguard Global Short Duration Bonds
• Vanguard UK Corporate Bonds

So, does my Plan still contain any passive fixed income investments?

Yes. In fact, we’ve recently added two new passive funds from HSBC to all Original and Ethical Plans: Global Corporate Bond and Global Government Bond.

It’s also worth noting that the government bonds within your Plan are all passive funds. Because these bonds only have a single issuer, there’s no scope for active management to add value to the selection process.

What’s the thinking behind this move to active, then?

“As well as increase Plan diversification, these new passive funds provide global exposure. By spreading your money across more countries, we're looking to benefit from the diverse economic and interest rate cycles we see across the world today.

“The new active funds provide another essential ingredient to our long-term investment strategy: expertise.

“Because these funds are actively managed by proven investment experts, they’re able to use their knowledge to identify the opportunities – and mitigate the risks – that passive funds ignore.”

— Jessie Kwok, Chief Investment Officer at Wealthify

Some of these opportunities include better:

Rates

When a new bond is launched, it often comes with a slightly higher interest rate (aka yield) to attract investors. Active managers can take advantage of this, whereas passive funds typically buy the bond later, with that initial opportunity gone.

Value

Because it's much bigger than the stock market, bond markets are often mispriced; active managers can use these inefficiencies to find attractive, undervalued bonds in less popular sectors. With passive funds only ever tracking an index, they can’t exploit this weakness.

Risk management

Active managers employ dedicated analysts to conduct deep credit research. By identifying weaknesses in an issuer before a major rating agency downgrades a bond, they can sell it early and protect your money.

Because index rules prevent proactive selling, passive's hands-off approach forces funds to hold these vulnerable, deteriorating bonds — even when the road ahead is clearly bumpy.

Rate hike protection

Bond prices are directly linked to interest rates; when rates rise, bond prices fall.

Active managers can strategically adjust your investments’ sensitivity to interest rate changes, shortening the bond’s duration defensively when rates are expected to climb.

As a result, this helps protect your money against the worst of the volatility.

Combining all these factors, it’s why smart investors are choosing active fixed income funds for their money — and why the smart money is with Wealthify.