Q: How do you decide between active and passive management when building your portfolios and are there any recent trends that have shaped your approach?
Tina Rönnholm, fund selector at the Swedish Fund Selection Agency (FTN): At the Swedish Fund Selection Agency, we don’t build portfolios ourselves. Instead, our role is to procure funds for the premium pension platform. In simple terms, we create the menu—our savers choose what to invest in from that menu.
The pension fund platform has a long history and today it consists of several fund categories, including actively and passively managed funds.
FTN is now tasked with building a new fund platform through public procurement and we plan to do this category by category. So far we have finalised three procurements, one for actively managed European funds, one for passively managed global funds and one for passively managed European funds.
We currently have five more ongoing procurements comprising actively and passively managed funds – actively managed Nordic large-cap equities, actively managed Nordic small-cap equities, actively managed Swedish large-cap equities, passively managed Swedish large-cap equities as well as actively managed large-cap global equities.
Our savers are free to choose which funds they want to invest in and they can switch funds as they desire and see fit.
Hannah Evans, head of manager research, Omnis Investment: We believe in active management but incorporate passive approaches where they enhance overall outcomes. Some asset classes have historically made consistent active outperformance more challenging, so we allocate to passive in those areas while prioritising active investing in parts of the market where we believe it is profitable to do so.
For example, in US large cap equities—where selecting successful active managers is statistically tougher—we introduced a passive fund manager alongside our active manager to improve diversification, enhance risk-return metrics and increase cost efficiency. With our new Agility range, we use passive instruments to be more active at the asset allocation level. Accessing passives through ETFs allows us to blend high-quality active managers with more precise tactical asset allocation.
Our approach to active versus passive isn’t binary. What matters is managing tracking errors in line with our conviction that it can generate alpha while ensuring an overall risk level appropriate for the market and our investors’ objectives.
Mark Preskett, senior portfolio manager at Morningstar Wealth: The active versus passive decision is a complex one, and several factors go into our decision-making. At its heart is an assessment of four things: market breadth, alpha potential, fees, and a base rate.
Breadth refers to the number of independent “bets” an active manager can make—in other words, how often the manager can apply their skill. For example, market breadth is higher in a global equity portfolio, with thousands of stocks to choose from, than in a UK gilt fund. Our assessment of alpha is driven by three of Morningstar’s five pillars for evaluating fund managers: process, people and parent. A positive assessment of these factors will lead us to allocate capital to an active manager, all else being equal. Fees are self-explanatory—the lower the fee for an active fund, the greater the likelihood of it being included in portfolios.
Finally, we have built a dataset that evaluates whether a Morningstar category has historically been a rich or poor hunting ground for active managers. This ‘base rate’ also plays a role in our decision.
Lionel Schwerer, portfolio manager, funds of funds, Generali Investments: It depends on whether the investment is tactical or structural. If it’s tactical, the rationale is usually driven by asset allocation, so I would opt for a passive ETF that offers both liquidity and cost-efficiency. If the investment is structural, then the choice depends on the market. In efficient markets—where active fund managers typically struggle to outperform indices—a passive approach is more suitable. Conversely, in inefficient markets with signs of mispricing, we aim to add value by selecting skilled active fund managers.
As for broader trends, ETF providers continue to expand their offerings, with increasing granularity in terms of sectors and factors. This growing depth makes it increasingly feasible to generate alpha relative to broad indices using ETFs. In turn, this heightened competition pushes active fund managers to focus even more on idiosyncratic risk—which is ultimately a positive outcome, as it aligns with the value investors expect when paying active management fees.
James Flintoft, head of investment solutions at AJ Bell: We are agnostic toward advisers choosing to use our passive, ‘pactive’, or active-based MPS [model portfolio service]. As seen across much of the industry, passive-based portfolios tend to be more popular. However, clients still seek some degree of active management—whether through a more formal blend in our ‘pactive’ MPS or via the more focused Active MPS.
Whenever we use active strategies, we take a nuanced approach to overall portfolio construction, incorporating passive elements where it makes sense. There are several examples within the Active MPS. For instance, we allocate passively to gilts, as we believe it is notoriously difficult for active managers to add value in this area without toggling duration—a risk we prefer to control through our asset allocation process.
Similarly, when we want to implement a tactical tilt, we typically use the same passive vehicle across all portfolios to ensure that returns are driven by our asset allocation decisions, rather than by an added layer of benchmark misfit or unintended active risk. Some cases are more marginal. For example, our China allocation is currently fulfilled using a passive strategy across all portfolios. This is due to the wide range of benchmarks used by active managers in the region, and so far, we haven’t found the right combination of benchmark alignment and active management that meets our criteria.
“FTN is now tasked with building a new fund platform through public procurement and we plan to do this category by category. So far we have finalised three procurements…” – Tina Rönnholm, fund selector at the Swedish Fund Selection Agency (FTN)
Q: What do you look for when evaluating whether a fund has strong long-term potential?
Tina Rönnholm: According to the law governing the Swedish Fund Selection Agency, the funds we procure must be suitable for the premium pension platform. They should also be controllable, sustainable, cost-effective and of high quality. Additionally, FTN must ensure real freedom of choice for its pension savers. We don’t have the luxury of focusing on only one of these dimensions but must look for funds that fulfil all criteria. A fund with strong long-term potential for us is thus a fund that scores highly on all of the above dimensions. Our procurement process and request for proposals are designed to find these funds.
Hannah Evans: When evaluating a fund’s long-term potential, we focus on the sustainability of its proposition. It must have durable capital markets support and a robust, repeatable process. The investment philosophy should be academically sound and rely on stable inputs.
Long-term potential isn’t just about generating high alpha; it’s about having a consistent, repeatable investment approach that gives us confidence in the fund’s ability to deliver alpha over time. This doesn’t mean alpha will be produced in a steady, predictable pattern—it means we can maintain conviction in how the investment manager applies their process and where their edge lies, even through varying market conditions.
We assess risk-adjusted returns, the fund manager’s track record, the investment team, philosophy, process and portfolio construction to determine whether a strategy has the resilience and repeatability needed for strong long-term performance.
“Some asset classes have historically made consistent active outperformance more challenging, so we allocate to passive in those areas.”-Hannah Evans, head of manager research, Omnis Investment
Mark Preskett: Morningstar’s process of fund manager evaluation is built around the ‘five Ps’. Process, performance, people, parent and price—which our analysts believe lead to funds more likely to outperform over the long term on a risk-adjusted basis. Each pillar is scored, and the combined score leads to an overall Medalist rating. The higher the rating, the stronger our conviction of long-term success.
To understand a fund, investors must understand the people behind them. This is not only the fund manager but also includes the analysts, traders and other managers who contribute to the process. We consider all of them when making our people assessment. The process is the most difficult to assess given the variety of fund strategies being employed by managers. Here competitive advantages are a key factor to assess.
We seek to answer questions like, is the manager doing something hard to replicate? Is the strategy a proven one or a new, untested formula?
Performance is more straightforward and we seek to focus on the long-term results and put less weight on nearer term numbers. Price is another relatively simple metric to assess and a factor that has good predictive power. The ‘parent’ pillar, however, involves more nuance. It encompasses factors such as manager turnover, the firm’s investment culture, the quality of its research, and its adherence to ethical standards.
Lionel Schwerer: We define strong long-term potential in terms of alpha generation, recognising that a fund manager is not responsible for the beta of the market they invest in—unless market exposure management is explicitly part of the investment process. In terms of value-added, the strong long-term potential lies in the repeatability of alpha generation, which reflects our entire due diligence process rather than any single variable.
This repeatability depends on the quality of idea sourcing—and more broadly, on the competitive advantages an asset manager can demonstrate in areas such as stock selection and portfolio construction. It also includes other dimensions, such as operational robustness, the strength of risk management and the effectiveness of trade execution.
Finally, market context plays a role as well. In efficient markets, strong long-term potential may be harder to identify and capture; in contrast, it becomes more tangible in inefficient markets.
“The active versus passive decision is a complex one, and several factors go into our decision-making.” – Mark Preskett, senior portfolio manager at Morningstar Wealth
Paul Angell, head of investment research at AJ Bell: Given our focus on simple, transparent, and low-cost investing, our unitised funds are made up entirely of index-tracking strategies. In this context, we look for vehicles that closely follow the appropriate index aligned with our asset allocation model, are low cost, have a solid performance track record, and are managed by asset managers with the appropriate scale and expertise. We are agnostic as to whether these funds are open-ended or ETFs.
When selecting active funds—used within our Active MPS proposition, bespoke model portfolios, and recommended lists—we assess a fund’s long-term potential using the conventional five Ps of fund research. These are: People – the calibre of the fund manager(s) and the team; Philosophy – the market inefficiency they believe they can exploit; Process – how they intend to exploit this inefficiency; Performance – their historical success in executing the strategy; and Price – whether the fund is available at a reasonable fee.
At AJ Bell, we also consider an additional three Ps: Positioning – whether the fund’s holdings align with its stated philosophy; Parent – whether the asset management firm has sufficient scale and a genuine commitment to the UK market; and Principles – whether the fund manager is a signatory to the UK Stewardship Code, or, if not, whether they have a credible explanation for their position.
Question: With alternative investments becoming more complex, how do you approach them, and what role do they play in the way you build portfolios?
Tina Rönnholm: So far, FTN has not procured any alternative investments. Our current priority is to procure the categories already available on the premium pension fund platform. Once this is completed, FTN will consider categories that are not currently represented on the platform but may be suitable in the future.
Whether this will include alternative investments remains to be seen. FTN requires daily liquidity, among other criteria, which may limit the eligibility of certain alternative investment funds.
Hannah Evans: We focus on how alternatives fit within our portfolios while still meeting our key needs: daily liquidity and diversification with a focus on decorrelation from equities and fixed income and offering us some protection when markets are not outperforming.
We look for investments that bring something different to the table reducing risk and smoothing returns rather than adding complexity. At the end of the day, alternatives should complement, not complicate our portfolios. We want them to add stability and improve resilience.
“In efficient markets—where active fund managers typically struggle to outperform indices—a passive approach is more suitable.” -Lionel Schwerer, portfolio manager, funds of funds, Generali Investments
Mark Preskett: Alternative investments are an area we have used sparingly in our multi-asset portfolios and complexity is a key factor behind this decision. Morningstar categorisation has been helpful in our assessment of these investments. A long-short equity fund provides very different exposures to an event-driven or global macro fund, for example.
We can therefore use the categorisation averages to assess how the different types of strategies might behave in different market conditions. As a result of this analysis, we focus on three types of strategies – trend following, equity market neutral and global macro in our multi-asset portfolios.
Our focus has been on more defensive-minded strategies, with lower volatilities and drawdowns than peers, rather than funds that can provide tremendous upside capture but struggle in more tricky market conditions. Diversification potential is also a key attribute. Has the fund been able to provide low levels of correlation to equities and bonds, particularly in times of market stress?
Lionel Schwerer: Whatever the complexity, the fundamental role of alternative investments remains the same: to generate alpha in a consistent and decorrelated manner relative to traditional investments. The increase in complexity is simply a natural evolution — one that cannot be avoided.
I would split the discussion into two cases. The first concerns existing alternative strategies, which often exploit market inefficiencies. Over time, as these strategies prove successful, they attract more competitors, making them less profitable. As a result, asset managers must continuously evolve and add complexity to their processes. Equity long/short funds are a good example: they are increasingly incorporating alternative data sources that were not available in the past. Our approach, however, remains consistent—conduct thorough due diligence. While the methods used may be more complex, the core of a long/short portfolio is still built on long and short positions.
The second type of evolution stems from the financial markets themselves. The growth of securitised products and derivative-based strategies has expanded the range of alternative funds available. This creates new opportunities to diversify the alternative segment of a portfolio even further.
Our due diligence process remains unchanged: we focus on understanding the fund’s alpha generation, its robustness and repeatability and its risk profile. This includes, among other things, analysing stress test results to fully understand the risks associated with the return potential—because, as always, there are no free lunches.
“As seen across much of the industry, passive-based portfolios tend to be more popular. However, clients still seek some degree of active management.”-James Flintoft, head of investment solutions at AJ Bell
James Flintoft: Everything we do follows our mantra: simple, transparent, low-cost. Many investments typically labelled as ‘alternatives’ often fall short on one or more of these criteria. Until recently, we considered infrastructure and property as alternative assets. However, after further research, we recognised that—in the form we were accessing them—they were essentially just equity sectors.
As of January 2025, these no longer have a place within our strategic asset allocation. That said, we may still use them tactically, as we would with any other equity sector.
For the right investor, alternatives can be a compelling asset class—but it’s crucial to assess whether the underlying volatility is reflected, or merely obscured by illiquidity.
