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Active Management FAQs

What is active management?

Active management is an approach to investing. See “What is Active Management?” for a description.

Why should investors consider active management?

What are the disadvantages of active management?

While active management has the potential to earn higher returns, there is a risk that those returns will underperform the relevant benchmark.

In addition, active management generally costs more than passive management, as active managers must pay for the resources needed to identify investments.

However, recent research suggests that active management provides a reasonable combination of return and cost.

Isn’t passive investing less risky?

Every form of investing involves risk of loss. Both active and passive investments are affected by the ups and downs of the markets. Buying index funds does not guarantee that investors will meet their financial goals.

At the same time, some of the common methodologies used to create indexes may increase exposure to higher-risk securities, such as stocks that have performed well recently, bonds of companies with large amounts of debt outstanding, or more expensively-valued securities.

Why do investors need active management? Isn’t passive investing enough?

Investors need both active and passive management. Pitting active against passive creates a false dichotomy that does investors a disservice.

All investing involves active decision making. For example, buying an index fund is an active choice, and even constructing an index involves active decisions.

Active management is used in all aspects of investing. In addition, index construction is itself an active process.

Active management allows investors to pursue higher returns and customize portfolios, while passive management helps reduce costs.

Through active investing, investors can customize portfolios to achieve their financial goals. For example, active management can help investors manage risk, focus on income, or implement a tax plan.

Passive management may not be available for certain types of investments or asset classes.

Active and passive management are often combined in the management of a portfolio.

In this video, Council Research Task Force member Apurva Schwartz of Harding Loevner discusses manager performance, whether successful managers can be identified in advance, and reframing the active/passive debate.

Isn’t it hard to find good active managers?

There is an extensive body of research finding that traditional approaches to selecting active managers — which consider past performance, investment approach and manager characteristics — can identify outperforming managers in advance.

And researching any investment opportunity requires effort – whether active or passive.

“Challenging the Conventional Wisdom on Active Management” by K.J. Martijn Cremers, Jon A. Fulkerson, and Timothy Brandon Riley, a research paper sponsored by the Active Managers Council, provides a summary of the extensive literature in this area.

Don’t active managers always underperform?

On the contrary, many active managers outperform. However, not all active managers outperform, and even the best active managers can underperform over some periods.

Importantly, investors need a long-term time horizon to measure the success of active management.

In general, the current media and regulatory narratives are overly negative about active management and focus too much on short-term outcomes.

In this video, Geoff Warren of Australian National University sets the record straight on active management, Sharpe’s famous theory, and active vs. passive investing.

Don’t the SPIVA report and the Morningstar Barometer prove that active management has failed?

The active-passive “scorecards” have a flawed methodology that generates an overly negative assessment of active managers’ skill. While the scorecards provide some insights for shorter time periods, they are far from definitive, especially over long periods.

The Active Managers Council publication “Rethinking Survivorship Bias in Active/Passive Comparisons” discusses one issue with the scorecard methodology.

Shouldn’t actively managed funds outperform every year? Isn’t this kind of performance “persistence” important?

Not at all. Even the funds that have produced outstanding 20-year results have had periods of short-term underperformance.

At the same time, focusing on short-term results only encourages performance chasing, a strategy that is widely acknowledged to be harmful to investors’ financial health.

How does ESG or sustainable investing relate to active management?

Sustainable investing inherently involves active decision making.

Active management takes a dynamic approach to the assessment of the materiality of ESG factors and how they affect specific companies, industries, or sectors.

Active managers also engage with corporate managements on how to address sustainability and consider how sustainability factors intersect with investor goals.

The Active Managers Council publication “Sustainable Investing is an Active Process” explains why ESG investment approaches are inherently active.

Isn’t investing in passive funds easier for retirement plan fiduciaries?

Focusing on passively managed funds doesn’t reduce the need for plan fiduciaries to make a thorough analysis of potential investments. Passively managed doesn’t equate to “not risky” or “uncomplicated.”

Nor should litigation risk or administrative convenience drive the fiduciaries’ decision-making process. Fiduciaries should only consider the best interests of plan participants.

The Active Managers Council publication “Defined Contribution Plan Fiduciaries and Investment Selection: Overview of the Legal Context” provides a more complete discussion of this issue.

What about active ETFs?

Active ETFs are exchange-traded mutual funds that use an active investment approach. They are another vehicle that investors can use to access the benefits of active investing.

Investor interest in active ETFs has been increasing.

What role does active management play in the markets?

Is there any evidence that the growth in index funds has led to less market efficiency?

Some researchers have noted increases in price correlations and in market volatility along with a decline in liquidity and changes in trading patterns. However, other researchers have argued that growth in passive management has had offsetting risk-reducing effects.

This is an evolving area of research, and markets are affected by many factors, not just the balance between active and passive management. However, the principle is clear: active management is an essential driver of market efficiency.

The Active Managers Council publication “Active Management and Market Efficiency” summarizes the literature on this topic.

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