Active vs Passive Investing — A Guide for New Zealanders

The active versus passive investing debate is the most persistent argument in finance. It has been running for decades and shows no sign of settling. Both sides have data, both have passionate advocates, and both are correct in different contexts.

The simple version: active investing means paying a fund manager to pick stocks or time the market, aiming to beat a benchmark index. Passive investing means buying an index fund that holds everything in the benchmark, accepting whatever return the market delivers. The passive approach is dramatically cheaper. Whether it delivers better net returns depends on the time period, the market, and the manager.

The Case for Passive Investing

The data is overwhelming for the US market. Over the past fifteen years, the vast majority of actively managed US equity funds have underperformed the S&P 500 index after fees. The pattern holds for most developed-market equity funds over most meaningful time periods. The reason is simple: active management is expensive, and the market is efficient enough that the extra cost is rarely justified by extra returns.

Passive investing also removes manager risk — the risk that your fund manager has a bad run, leaves the firm, or simply makes the wrong call. An index fund does not depend on any individual's judgement. It follows the market mechanically. The fee you pay is minimal, and the return you get is the market return minus that fee, which is as close to a guaranteed outcome as investing provides.

For a New Zealand investor building a portfolio of global equities, a passive approach using a low-cost fund that tracks a major index is the default starting point. The fund holds thousands of companies across dozens of countries, providing broad diversification at a fee of a fraction of a percent. Over a twenty to thirty year investment horizon, the compounding benefit of that low fee is substantial.

The Case for Active Investing

Active managers in less efficient markets can and do outperform. Smaller markets like the New Zealand share market, where there are fewer analysts covering fewer companies, give skilled managers more opportunity to find mispriced stocks. Some New Zealand active fund managers have produced returns above the NZX 50 index over extended periods — not consistently every year, but over full market cycles.

The best active managers also offer downside protection. In a market crash, an active manager can hold more cash, avoid the worst-performing sectors, or overweight defensive stocks. Index funds have no such flexibility — they must hold everything in the index, good and bad. Over a severe bear market, the best active managers lose less than the index, which gives them a head start when the recovery begins.

Private markets — unlisted companies, infrastructure, property — are almost entirely the domain of active managers. These asset classes are not available in index fund form. An investor who wants exposure to NZ unlisted businesses or direct property investments needs an active manager to select and manage those investments.

The Middle Path

The most common approach among experienced New Zealand investors is a core-and-satellite portfolio. The core — typically sixty to eighty percent of the portfolio — is invested in low-cost passive index funds covering global and New Zealand shares. The satellite portion is invested in one or two active funds where the investor has conviction that the manager can add value.

This structure captures the benefits of both approaches. The core delivers low-cost market exposure and removes the risk of underperforming the market. The satellite gives the opportunity for outperformance through skilled management. If the satellite funds underperform, the core still delivers the market return. If they outperform, the overall portfolio beats the market.

Picking the active funds is the hard part. Past performance is not a reliable guide to future returns, and the best-performing fund over the past five years is often not the best performer over the next five. Looking for managers with a clear investment philosophy, a stable team, competitive fees, and a track record across different market conditions is a better approach than chasing last year's top performer.

Fee Comparison in Practice

The fee gap between active and passive funds in New Zealand is wide. A typical KiwiSaver default fund run by a bank charges around one percent per year. A Simplicity or Kernel passive growth fund charges about a quarter of that. On a NZ$100,000 balance, the difference is several hundred dollars per year — every year, regardless of performance. That difference compounds powerfully over time.

The active manager needs to outperform the index by the full amount of the fee gap just for you to break even. If an active fund charges 1.00% and the index fund charges 0.25%, the active fund needs to beat the index by at least 0.75% every year just to match the index fund's net return. That is a high bar to clear consistently. Most active funds do not clear it over extended periods.

This does not mean active management is worthless. It means the fee matters more than most investors realise. An active fund that charges 0.50% and beats the index by 1.00% per year is a good investment. An active fund that charges 1.50% and matches the index is a poor investment. The fee is the single best predictor of future relative performance, because fees are guaranteed and outperformance is not.

Tax Treatment Considerations

Active and passive funds in New Zealand are both typically structured as PIE funds, meaning the tax treatment is the same — investment income is taxed at a capped rate of 28%, and capital gains within the fund are not taxed separately for most investors. The tax structure does not favour one approach over the other.

The difference that matters for tax is turnover. Active funds trade more frequently, which can generate more realised gains that are distributed to investors and taxed in that year. Passive funds have low turnover, so gains are mostly unrealised and accumulate within the fund without triggering a tax event until the investor sells. For a buy-and-hold investor, the lower turnover of passive funds means more compounding on pre-tax returns. This is a modest advantage for passive investing, not a decisive one, but it adds to the overall case for low-turnover strategies over time.