Unlocking Real Value Blog

AK In The News: Active v. Passive Investing

I was asked to comment for an Ignites (a FinancialTimes Service) article on active versus passive inviting. Fidelity and American Funds recently put out research showing active management outperforms passive management. Like all studies on this topic, however, these results were achieved by implementing a screening on the large universe of available funds.

In the American Funds study for example, the firm screened for funds in  the lowest-quartile for net expenses and highest-quartile for management ownership. Had they picked different screens, of course, the results would have been different.

What was done here was no different that how one can manipulate performance by choosing a particular period of time over another. The process is extremely subjective and often produces the desired results.

So what is the lesson here? The lesson is that the argument of which is better – active or passive management – will continue into the future. Active management has taken a hit during the bull market because until recently there have been few down periods when active managers have been able to show their real value added – down market protection.

In reality, there are positives and negatives to both types of management. Passive, for example, has started to take a hit with recent questions about ETFs and their proliferation and their role in last summer’s mini-crash.┬áMany investors choose to combine active and passive funds in their portfolios.

The issue gets thornier for many of the sponsor firms, since they offer both active and passive funds, and must walk a fine line between “bashing” some of their own funds. They can do this, however, by showing the relative advantages of each and the rationale for having both types of investments in a diversified portfolio.

For advisors, this argument illustrates the need for a solid due diligence process – to be able to select from the many thousands in each category – those that are more apt to outperform and to be able to articulate to clients why they are choosing particular funds for them. They also must illustrate why the combination of the two might be more effective than a portfolio of one or the other.

The arguments will go on ……..

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