Amateur investors continue to move money into passively managed funds. However, according to Ignites Research, elite professionals are largely using actively managed funds, favoring active managers by a ratio of 4 to 1.
What explains this contrarian approach? The answer is risk control. Passively managed funds don’t have the ability to use judgment, being required to continue to match an index no matter what. And as the markets have become increasingly volatile, passive funds are at the mercy of traders who don’t care about fundamental values.
When markets are going up consistently, a case can be made for passive index investing. However, when the market is roiled by rumor and headlines that have little to do with economic fundamentals, passive funds are at the mercy of short term traders. Actively managed funds can take advantage by shopping for bargains. Active managers can raise cash to ride out temporary storms, something that passive funds don’t do.
Amateur investors are attracted to passive investing after years of being sold on low fees and performance claims. However, low fees – measured as fractions of a percent – do little to help the investor watching his or her investments drop by 10, 15, or 20% during bear markets.
And those performance claims assume that the alternative to an index fund is the average of all actively managed funds. This is simply not the case. One leading portfolio manager puts it this way:
“It’s a myth that you can’t find outperforming active managers who can beat their benchmarks over time. So for us, sorting out and tracking the best active fund managers is a worthwhile pursuit and helps add value for our clients.”
We agree. At a time of increased volatility and lowered expectations it’s a good time to get a professional review of your portfolio.