Over the last decade-plus, passive investments have outperformed actively managed funds. In September 2019, inflows into passive investments caused U.S. index-based equity mutual funds and ETFs to surpass actively managed funds for the first time ever. From Peter Lynch to Warren Buffett, everyone was getting on board with passive management as the way of the future.
According to The Cyclical Nature of Active & Passive Investing, a paper recently released by Hartford Funds, however, active and passive investing look to be cyclical. The paper looks at the last 35 years of passive versus active investing, revealing: “Just when it seems that active or passive has permanently pulled ahead, markets change, performance trends reverse, and the futility inherent in declaring a “winner” in active vs. passive is revealed anew.”
While there is no doubt that passive investment has performed better for the past decade, we may now be witnessing a swing back toward active management. It’s easy for investors to fall prey to “recency bias,” which is a tendency to believe that recently observed patterns will continue into the future. It’s a powerful influencer but investors who don’t take into account history are doomed to repeat past mistakes. It’s important not let yesterday’s events cloud tomorrow’s investment decisions.
Active Management Does Better During Corrections
According to the Hartford Funds paper, active management may be preferable when corrections occur.
Over the past 31 years, there have been 26 market corrections. During that time, active has outperformed passive 19 out of 26 times, with an average rate of outperformance of 1.48%.
Active Advantage
Active management allows investors to respond to ever-changing markets. This empowers them to “maximize opportunity as conditions demand,” according to Hartford. If you’re invested in an index fund, however, you may be “exposed to significant downside due to single-sector performance.” Examples from this are obvious, such as tech bubble burst back in 2000.
When bear markets take over and markets begin to correct, passive managers may be left holding markets with inflated values. Active managers, meanwhile, are able to mitigate risk by reducing exposure to areas that are hit hardest during a market downturn, i.e. oil, and increase exposure to asset classes that roar upward as the markets begin a new cycle.
