The classic passive investment approach involves a strategic allocation of the assets in the market index portfolio and money market fund or risk-free assets, like US Treasuries.
The allocation strategy allows the investor to identify the risk-return trade-off thus determining a suitable rate of return for the portfolio. The most popular allocation strategy involves investing of approximately 60% of the portfolio to the market indices, 30% to the risk-free assets (US Treasuries), and the remaining 10% of the portfolio to the money market fund thus achieving a diversification effect that secures the portfolio from the unfavorable (for the investor) market swings. Currently investing in market indices involves not only purchasing index funds, but also investing in Exchange Traded Funds (ETF) that may represent both the index and sub-index. Both index funds and ETFs mimic the content and hence the performance of the indices (or sub-indices) that supports the underlying idea of the passive investment management approach. Although investing in market indices may seem more attractive due to the much simpler and cheaper way of investing as compared to the active investment management, the ma
rket index funds have the same downside potential as the real market indices. This justifies investing into the risk-free assets (US Treasuries or money market funds) thus diversifying the risks associated with investing into market indices only.
The Utility Value measure is one of the possible ways to determine the optimal rate of return for the given portfolio taking into consideration the investors risk aversion in quantitative terms. This allows the manager to compare the Utility Value with the expected return on the portfolio thus tailor the portfolio composition based on the mean-variance criterion of the investor.
Moreover, a passive strategy may also be described as one that does not require any direct or indirect security analysis for the portfolio decision that may sound logic if the investor is going to exploit the forces of supply and demand. The underlying assumption of the passive strategy is that markets are efficient and all the securities are enough fairly priced to make the underpriced/overpriced division impossible. It can also be characterized as 'buy-and-hold' strategy due to broad diversification that usually makes impossible rapid swings in the value of the portfolio and efficient pricing of securities.
Although the passive strategy may seem more attractive than active one due to its simplicity and lower price, it also has disadvantages. A passive strategy is highly dependable on the market index, thus it possess the same downside potential. Furthermore, if the markets are not enough efficient, it may bring significantly less return than active strategy.