Why Active Management is Essential to the Markets and Your Portfolio
September 11, 2018
Active management provides important value for investors.. For the past 20 years, however, the public perception of active management has been centered around a negative --namely, that active management isn’t lower-cost than index funds. The narrative seems to be that passive management is cheaper – and therefore better, while active management underperforms, largely because of fees.
But this one-dimensional characterization of active management misses many of its most important attributes. Active management is:
- A key component of investment portfolios, for both individuals and institutions
- A value-added contributor to portfolio returns
- An essential element of any financial plan
- A critical driver of the health of the financial markets
- A major contributor to the strength of the economy
In other words, active management provides an important service to investors, the markets and the economy. It’s time for a new narrative about the value of active management. To that end, the Investment Adviser Association has formed the Active Managers Council to provide education and research on the value of active management and to engage on related public policy issues. Through research papers commentary and educational material available through its new portal, the AMC aims to be a valuable resource for investors and policymakers seeking to learn more about the role of active and passive investment strategies.
Its work is based on the following 4 ideas:
Active management adds value
Contrary to the conventional wisdom, active managers can predictably add value for investors on a risk-adjusted basis.
Many managers have provided superior results over long periods. At the same time, investors can identify these skilled managers in advance, by looking at past performance, investment approach, manager characteristics and the investment.
Given its value, it’s no surprise that active management remains the primary investment approach around the world. Here in the United States, 63% of mutual funds – or $11.4 trillion* --are actively managed, even with the recent growth in index investing.
Active management is a part of every investment decision
Every investment decision involves an element of active management. Even the decision to invest in an index fund requires active choices (which fund? how much? when?)
Active decision-making is a key component in financial planning, including retirement planning, which involves structuring a multi-asset portfolio to align with an investor's needs. Put simply, individuals cannot meet all their investment needs by buying a single index fund.
Active management and passive funds work well together
Active management and passive management each have their strengths and weaknesses. Active management enables investors to navigate complexity, to customize portfolios, to capitalize on specific skills or to profit from market inefficiencies. Passive management helps to reduce costs.
Most investors will benefit from a combination of the two approaches, with the mix determined by their particular objectives, skills and risk-tolerance.
Active management is essential for healthy markets and economies
Active managers perform the investment research that makes markets efficient. They ensure that prices remain in line with underlying fundamentals. Without their work, markets would be more volatile, less liquid and more unpredictable.
In addition, active managers play an important role in corporate governance, by encouraging strong stewardship and a shareholder orientation at the companies they invest in.
Finally, they support capital formation and entrepreneurship by providing a market for IPOs and other forms of capital raising.
To stay up to date on the new narrative on active management, be sure to subscribe to this blog. You can also learn more at the Active Managers Council's website.
*Morning Star's Annual Fund Flow Report