Choice is at the heart of investing; one can’t own everything. But should investment choices be made in a mechanical way, based on an index? Or should they be made selectively, based the research and expertise of an active manager?
What Active Brings to the Table
A decade of broad market gains, fueled by artificially low rates, has benefited passive strategies and led many to question the role of active management.
But it would be rash to draw sweeping conclusions from such an unusual period in economic history. At other times, the flexibility that defines active management has been essential to generate the income and/or returns desired by investors – and may well be again.
There are, in fact, multiple reasons to choose active management – including the potential to selectively control risk, moderate losses in a down market and to generate outsized risk-adjusted returns by seeking opportunity outside traditional benchmarks.
Active + Passive: Complementary Strengths
The truth is that there are virtues to both approaches; while often talked about as opposites, they are in fact quite complementary.
Passive strategies provide broad market exposure, but leave investors exposed to the possibility of price declines. And as we’ve seen since the financial crisis, big changes in the macro environment can introduce unexpected concentration risks in traditional benchmarks.
“If ‘market’ returns do not generate the income or growth needed by investors, something more than ‘market’ may be required"
Active strategies, on the other hand, are well placed to address these issues. In declining markets, they may reallocate assets away from risk, and make pre-emptive adjustments when the macro environment appears uncertain. What’s more, they can take advantage of short-term mispricing to generate incremental gains.
Given these complementary traits, a portfolio that combines active and passive offers tantalizing possibilities. The key is to find a balance that reflects an investor’s goals and which leverages the strengths of both approaches. In addition, it’s important that the active strategies selected are truly active – that they differ significantly from available index strategies – or the investor won’t reap the potential benefit of diversifying between the two styles.