Three Reasons to Consider Active Management

Share Post: facebook Created with Sketch. twitter Created with Sketch. linkedin Created with Sketch. mail Created with Sketch. print Created with Sketch.

Published by Brett Carson

Trends are pervasive in our culture, and the investment world is no different. The latest is the move towards passive investing using low-cost ETFs. Essentially, the argument is that nobody can consistently beat the overall market, so you’re better off owning a cheap index fund with the aim of just keeping pace with it. This stands in contrast to active investing where portfolio managers charge higher fees to research and select individual assets with the goal of outpacing market returns. Recently, the passive camp is winning and it’s not even close. According to the Financial Times, just 19% of large-cap mutual fund managers beat their benchmark in 2016, and passive funds grew five times faster than the active management industry in 20161. In fact, passive funds have outperformed active managers six out of the past seven years! Case closed. Game over. Right? I believe that the death of active management has been greatly exaggerated for the following reasons:

Active Versus Passive Management is Cyclical

The fact of the matter is that both styles go in and out of favor. While passive management is currently wearing the crown, it was the active camp that outperformed passive in nine out of 10 years during the 2000-2009 period. During the 1990s, passive bested active seven out of 10 years. Over a longer term, there is no clear winner. Over the past 32 years, active has outperformed 15 times and passive has won 17, according to Morningstar2. In short, investors should allocate to both styles.

Active Strategies Proactively Manage Risk

Most passive investors define risk in a very simple way – volatility. The more volatile an asset or sector is, the more risky it must be. They then allocate their assets across security types (bonds, stocks, real estate, etc.) and sectors (tech, utilities, financials, etc.) based upon its historical volatility. There is no consideration given to the underlying securities held in index ETFs. Most buy that basket of securities blindly without knowing what’s inside. On the other hand, active managers look at risk much more broadly. Not only is volatility considered, but also valuation, technical risk, business and industry risks, macroeconomic factors, among others. Many think active managers’ primary goal is to pick outperforming stocks. Rather, I would argue that they are actively managing risk.

Remember the movie, The Big Short, and the scene where Christian Bale’s character is combing through all the individual loans inside of mortgage-backed securities to identify the bad ones that he wanted to bet against? That’s what active managers do – avoid risky investments (or bet against them in this case). To continue the analogy, passive investors would look at that AAA-rated mortgage-backed security and measure its risk by its historically low volatility, which unfortunately is what a lot of people did.

True Active Managers Can Take Advantage of Market Inefficiencies

Warren Buffett once said, “I’d be a bum on the street with a tin cup if the market was always efficient.”  What he means is that through conducting deep research on companies, he can identify situations where stocks are underpriced relative to their intrinsic value. This is another key advantage of true active management – the ability to overweight securities that are undervalued. This stands in contrast to passive strategies that weight the underlying securities by market capitalization, or size. I say “true” because there are quite a few actively managed funds that structure their portfolios to be very similar to that of its benchmark. After charging relatively high fees, these are almost destined to underperform over time. There are pockets of the market that tend to be more inefficient than others (small caps, international), and there are periods of time where the broader market becomes inefficient as well. Unlike passive, active managers can be opportunistic and capitalize on such situations.

The active versus passive debate will rage on, and as history shows, active managers will have their day in the sun once again. My advice is to take a balanced approach and don’t try to time when the next shift occurs.

 

 

Share:
facebook Created with Sketch. twitter Created with Sketch. linkedin Created with Sketch. mail Created with Sketch. print Created with Sketch.
Share Post: facebook Created with Sketch. twitter Created with Sketch. linkedin Created with Sketch. mail Created with Sketch. print Created with Sketch.

RECENT POSTS

Charitable Giving Strategies in a High-Income Year

Tom Fridrich, JD, CLUⓇ, ChFCⓇ, Senior Wealth Planner  The end of the year offers an ideal opportunity to look both forward and back — reflecting on recent achievements, while setting goals for the upcoming months. For many of my clients, it’s also a time to review their finances and i …

Let’s Talk About Midterm Elections and Your Investments

This week was midterm elections and we’ve had many questions about what it all could mean, which we’ll tackle in today’s blog. We consider it a great honor to vote, and while we may not know the final results of the election for days (or even months), what we do know is the election will …

3 Nontraditional Ways to Give That Still Qualify for a Tax Deduction

Kevin Oleszewski, Senior Wealth Planner ‘Tis the season to give. In fact, 37% of charitable giving occurs during the last quarter of the year — 20% of it in December alone, according to a survey conducted by the Blackbaud Institute. And while the holidays are traditionally a time to reflect …

Considering Tax Loss Harvesting? What You Need to Know First

Kevin Oleszewski, CFP® Senior Wealth Planner As the tax year draws to a close, many high-income investors will look to reposition their portfolios to intentionally generate losses as a way to offset gains — an investment strategy known as tax loss harvesting.
1 2 3 110 111 112

Get in Touch

In just 15 minutes we can get to know your situation, then connect you with an advisor committed to helping you pursue true wealth.

Schedule a Consultation