Come on, folks. Let’s stop the silliness right now. I can’t tell you how many times in recent weeks I’ve read about the demise of active managers versus passive offerings, but I can tell you that it has been too many times. This discussion of passive versus active has been around since the creation of passive indexes, and it will remain a topic of conversation for a long time to come.
The KCS team has addressed this issue in prior blog posts, but given the recent fervor, we felt that it was necessary to discuss this topic again. There are cycles throughout the capital markets, and it is no different for active equity managers versus their passive equity benchmarks.
There are portfolio biases that favor passive versus active and vice versus. Active managers tend to do better when small capitalization stocks and value-oriented stocks / sectors are in favor. In addition, active managers tend to do better when markets are falling, as they often have cash reserves that help support portfolio performance. These are portfolio construction issues given that most active managers build equal weighted portfolios, and have stock selection criteria that screens for value (price to something).
Passive portfolios, particularly larger cap indexes, benefit from momentum, rising markets, and large capitalization leadership. These are the areas that have most recently been in favor (last 3 years), and so it isn’t surprising that active managers would be struggling in this environment. Does this mean that something has changed that will always create this opportunity for passive investing? Hell no!
There are certain segments of our capital markets that are more difficult to add substantial value add, but given the cycles in the markets there will always be opportunities. We suggest that plan sponsors use both active and passive strategies to achieve their desired equity exposure and tilt to one versus the other when portfolio construction biases make sense to do so.
In addition, be careful what you pay in fees, and consider using performance fees to insure that you are only paying for value-added strategies. Also, assets under management are an important consideration, too. There are too many asset gatherers that have built asset bases that far exceed their product’s natural capacity to add value. Small can be a beautiful thing!