The Active vs. Passive Funds Debate: Who Wins?

Debates over the use of ETFs in portfolios generally are focused on active versus passive and overlook their ability to be an asset allocation tool.

Analysis of the active/passive debate is plentiful, but most of the debaters are firmly on the side of the latter.

A recent study done by Cass Business School concluded that about 2% of all actively traded funds outperform their benchmark. Additionally, over the last 10 years there have been some interesting results about which funds failed to outperform their benchmarks, states James Smith of City Wire:

• 59% of large-cap blended funds in the United States failed;
• 71% of large-cap value funds;
• 34% of large-cap growth vehicles;
• 73% of small-cap blended funds;
• 64% of growth managers;
• 65% of value managers;
• 75% of short-term high yield vehicles;
• 100% of actively traded bond portfolios, focused on medium-term corporate paper and long-term government debt.

Some providers already claim that they will start providing traditional active mutual funds and active ETFs as soon as they make economic sense, in essence become profit-neutral, states Tony Baker, managing director of index and exchange traded products at NYSE Euronext.

Some believe that the effects of the credit crunch, market meltdown and global economic crisis are the reasons that many managers have been unable to beat their benchmarks. 2008 was a crazy, unpredictable year, and the aforementioned have significantly impacted returns.

Comments

[Firat Ünlü:]

If anything 2008 was a perfect year to outperform the index and make up for previous losses, anyone that's failed to see this bubble deserves no further money to invest with. But considering most people are financially inept, never mind even slightly interested, fund managers will have money to play with soon again.

Jan 05 08:14 AM

[Internet2k4:]

The point of index investing is to accept overall market and sector risks but avoid the corporate management risk inherent in stock picking. Active fund management is just a half-way house for reintroducing management risk - in fact it adds another dimension of "manager risk." Been there, done that, never again.

Jan 05 09:22 AM

[Roger Schre...:]

Tom,

There should be no debate, passive investing is risky and dangerous to your wealth. I would not consider any of the stuff in your list as seriously "active." Just because they move things around, they stay full invested. "Active investing" should include cash or money market at times of high risk.

As you know we "actively manage" our portfolios on a daily basis. Almost all of our strategies were positive or flat on the year, we even had two that were up double digits, one of them up about +30% in 2008. Our active portfolios take LESS RISK than passively invested strategies, and LESS RISK than those you classify as active (above).

Do you know ANYONE who would select a passive approach over an active approach in a goal-oriented endeavor? Niether do I. Investing is no different than any other goal-oriented endeavor, you need to actively manage your assets to prevent getting killed in markets like we are experiencing.

It is sad that the mutual fund industry has persuaded investors to accept passive investment as a serious approach. Any approach that does not have an escape plan is worthless. It is time to be honest.

There are advisors and firms out there that can outperform buy-and-hold. Justs because there aren't many, isn't an acceptable reason to buy and hold. I can't believe it's ever sensible to buy-and-hold, the risk is just too great. It's time to be honest with the American public and with individual investors about the unacceptable high risk of buy and hold.

Roger Schreiner
Schreiner Capital Management
scminvest.com

Jan 06 08:53 AM