7 Reasons to Choose Active Now

7 Reasons to Choose Active Now

While index investments have their place, it’s important to recognize what actively managed strategies can do for investors – especially in the current environment, where the risks embedded in passive strategies loom large.

Where and how to allocate across active strategies is a decision where an investor’s specific needs and expectations are critical. Rather than succumb to stereotypes about the merits of active vs. passive, it’s important to take a nuanced view that recognizes the huge range of active strategies available as well as the market conditions that favor active now.

  • Industry averages don’t tell the whole story. Statistics about the performance of active funds overall have reached differing conclusions through the years. But what matters to investors is the performance of the active funds they actually own – which can vary greatly. The key for investors is to focus on managers whose approach is truly distinct from the indexes – and be wary of so-called “index huggers” which are not different enough to truly outperform. 
  • Investor needs may demand outperformance. Many investors have aggressive goals and/or imminent priorities that may only be realized with returns greater than passive strategies can provide.  In many cases, the outperformance possible through active strategies may be the only way to meet these goals without formally reallocating money into higher-risk sectors.
  • Indexes may pose real risks. Indexes are not averages of the whole universe of securities in an asset class. Instead, they are models constructed around assumptions – many of them arbitrary – about what to include and how to weight it. Unfortunately, over time, those assumptions can introduce unanticipated risks. Example: the huge increase in Treasuries as a component of the popular Bloomberg Barclays US Aggregate Bond Index that’s taken place since the financial crisis exposes passive investors to unwanted duration and interest-rate risk.  Another example: the concentration risk inherent in a cap-weighted index like the S&P 500, with the top 10 stocks accounting for over 18% of its value.  But do those stocks represent the best chance for future gains?
  • Some sectors are naturally suited to active. In specialized markets, where information is harder to come by – think small-cap stocks, emerging markets stocks, global high yield – active managers can add value by using their expertise to identify securities that are underpriced relative to their fundamentals.
  • Active can preserve as well as grow assets. After fees, a passive index strategy will gain all that its benchmark gains – but also lose everything its benchmark loses.  In contrast, active strategies have the option to adjust holdings in response to adverse conditions; indeed, the alpha generated by an active strategy can be traced to “downside capture” as much as gains from well-chosen securities.  At a time when valuations in many stock and bond sectors are historically high, and when rates may be poised to rise, active’s flexibility offers a measure of prudence as well as potential gains.  
  • It’s an uncertain world; can you afford not to use both approaches? Market surprises in 2016 underlined the difficulty in predicting what’s coming next. The long run of gains since the financial crisis that buoyed passive strategies may not necessarily be the arc of the future.  A recent analysis by eVestment Alliance of passive and active large-cap stock returns from 1985 to 2015 showed a cyclical pattern in the performance of the two approaches over the last 30 years; however, recognizing that a pattern may exist doesn't mean one can anticipate the start and end of a new phase -- meaning it's wise to hold both types of investments.  
  • Investors deserve to have choices. Accepting the ups and downs of active investing is not simply a financial issue. It’s also one of temperament. Some people would rather take a chance on outperformance than settle for the mediocrity of an index return, accepting the risks of underperformance. As such, the issue is the type of risk one wants to accept in one’s portfolio – something that reflects personal attitude as surely as the level of volatility one is prepared to accept.

IMPORTANT INFORMATION: All investments involve risk, including loss of principal. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not  take into account the particular investment objectives, financial situation or needs of individual investors.