Active vs. passive investment approaches evolve amid great financial market turmoil

As global markets navigate 2025's unprecedented volatility and investors worldwide reassess their strategies in the face of an unrecognisable investment and geopolitical landscape, the decades-old debate over whether to invest in actively managed or passive funds is being abandoned in favour of sophisticated hybrid approaches that harness the cost efficiency of passive strategies alongside the market-beating potential of active management.

The active-versus-passive investment debate has been a highly contentious issue within the investment field for over 60 years. The reasoning for this is quite simple - it substantially affects how we "should" invest.

What is clear is that modern portfolio construction has begun to transcend the traditional either/or approach in favour of more nuanced strategies that leverage the strengths of both methodologies, incorporating private assets that require active management and provide added diversification characteristics at a time of great financial market turmoil.

Throughout the 1960s, 1970s, 1980s, and 1990s, vast amounts of research articles were published in prestigious financial journals, all of which showed fairly robust evidence of passive funds' superiority over their active counterparts.

Within academic finance, the preference for passive versus active funds was treated as "conventional wisdom" for a substantial period of time. The investment industry only warmed up to passive fund products later, as investors' appreciation of the positive impact lower costs have on portfolio performance grew.

Beyond the Traditional Debate
Looking back at decades of debate, were the passive managers right all along? Well, kind of - but not completely. It turns out that all those studies referred to earlier shared a common limitation: they all examined actively managed funds in the US equity markets, one of the most efficient markets in the world. Most investment portfolios, including Stonehage Fleming's, don't consist solely of allocations to the US, nor are they limited to equities.

Over the 2000s and 2010s, the analysis of the benefits of passive and active management expanded to other regions and asset classes, yielding mixed results. Again, most of the findings supported passive funds, but with important caveats that introduced potential qualifications to the findings of the various studies. Investors began measuring performance more precisely, studying performance over different time periods, using more sophisticated vehicles, and gaining greater access to previously unavailable market segments.

Despite the inconclusiveness of the debate between passive and active approaches, three key findings have emerged from the existing literature.

1. Costs matter - a great deal. Cheaper funds systematically outperform more expensive ones, whether active or passive. In more competitive markets, active funds tend to pursue product strategies that aim to deliver alpha while charging lower fees for that management.
2. Many active (and passive) managers aren't as active (or passive) as they claim to be. Research finds that markets with less competition from passive funds have more "active" funds that are closet index managers, despite charging active management fees. Meanwhile, the ETF space is seeing more actively managed "passive" funds.
3. It's not possible to invest completely passively in all markets, particularly private markets, which are becoming increasingly incorporated into diversified portfolios because they are uncorrelated with publicly traded asset classes.

A New Era of Cost-conscious Hybrid Portfolios Incorporating Private Assets
So, we've definitely gained much deeper and more nuanced insights from the many decades of back-and-forth debate. It has made us better asset allocators from a practical perspective. Cost consciousness, due diligence on manager activity, and access to privately held assets can, empirically, help us construct better portfolios.

However, what is the answer to the original question - should you choose one over the other? To date, the guidance is as follows: use both. The inclusion of private assets will inevitably require you to use active funds for that portion of your portfolio. However, for the parts of your portfolio that access the public market, the complexity lies in determining which market is perceived as efficient at a given point in time.

Principally, you'd want passive funds in the parts of your portfolio that target efficient economies, and active funds in the parts that target inefficient economies. And if you're uncertain, going passive will likely skew the probabilities in your favour.