Active vs Passive Management
The Case for Actively Managed Strategies
The Wall Street Journal recently ran a series of articles regarding active and passive management, declaring “investors are giving up on stock picking” and instead are “flooding into passive investment funds.” (See “The Dying Business of Picking Stocks,” The Wall Street Journal, October 17, 2016.)
Certainly, the flow of funds into passive investment vehicles is indisputable. Investors have added nearly $1.3 trillion to passive funds over the past three years, while more than a quarter trillion dollars has exited actively-managed funds over the same time period. Investors clearly have accepted the narrative that passive investment vehicles, due to their low cost structures, outperform actively-managed investment vehicles, on average.
Despite this trend, at Boston Private, we believe there is a strong case to be made for active management, especially for investors with complex financial lives.
Active Management: More than beating a benchmark
One of the myths of active management is that the ultimate goal is to beat a benchmark. Active managers, though benchmark conscious, incorporate multiple parameters when designing investment strategies. These parameters include but are not limited to: risk controls, volatility constraints, tax considerations, limited downside capture, social impact, and a minimum yield. In other words, active managers are able to align their strategies to meet an investor’s unique objectives.
An actively managed portfolio holding individual stocks can offer much more control over tax liability. While passive investing is considered more tax efficient because of the low turnover within each index fund, it is not always the ideal vehicle for tax management.
For example, a client recently asked us to raise $600,000 in cash in his U.S. equity portfolio. The portfolio had unrealized gains of 14 percent. If the portfolio had been invested in an index fund, raising the cash would have resulted in $83,000 in capital gains. However, because the portfolio held individual stocks, we were able to select specific stocks and even specific tax lots within the equity holdings. As a result, we raised the cash and strategically realized $89,000 in losses — reducing the client’s tax liability for the year. This simply wouldn’t have been an option in a passively managed portfolio.
This is just one example of why we strongly believe that skilled active managers are better suited than passive strategies to help investors achieve their goals.
Why Passive is winning, for now
First, it’s important to point out that the proliferation of passively managed mutual funds and ETFs has occurred during one of the longest bull markets in history. In this limited volatility environment where momentum trumps fundamentals, passive investments have performed well since the Great Recession of 2008. However, true to the nature of index investing, a passive portfolio that rides the wave of a broadly successful market also mimics the depths of its decline.
A recent study conducted by global asset management company AMG examined actively managed large-cap funds and concluded that only in the most robust bull markets did the median active manager underperform. In periods when the S&P 500 Index declined by more than 10 percent, actively managed funds posted the greatest outperformance relative to the index. Focusing on manager returns over full market cycles enables one to assess the performance of an active manager in both up and down markets, highlighting their ability to provide both upside capture and downside protection.
At Boston Private, we believe that active management is critical for capital preservation in a market downturn and to achieve long-term investment goals. We select active managers and manage proprietary equity and xed income strategies that prioritize not only upside capture, but downside protection as well.
How Boston Private selects active managers
Active management is at the core of Boston Private’s investment strategy. We manage proprietary strategies and select complementary external active managers that consider risk, downside protection, income and more. As an outcome-focused institution, we form customized asset allocation approaches, implement tax strategies, and create holistic wealth management solutions to help our clients build and protect wealth for the long term.
Boston Private has a defined, rigorous due diligence process for selecting investment strategies managed by external portfolio managers.
More About External Manager Selection
Boston Private’s Investment Team uses fundamental analysis to determine in which type of market environments specifc companies, asset classes, and external managers will struggle and in which they will outperform. By understanding the strengths, weaknesses, and differences among selected active management strategies and our internal proprietary strategies, we construct complementary portfolios customized to meet each of our clients’ needs.
Fees are also an important consideration when comparing active and passive investments. While many active managers earn their fees, others do not. That’s why manager selection is key. On both a 1-year and 10-year basis, the top 25 percent of all large-cap funds outperformed SPY, the SPDR S&P 500 ETF through June 30, 2016.
Choosing strong active managers is essential to long-term success. It is not coincidence many of the traits we seek in external active managers are paralleled in our proprietary equity and xed income strategies. We create internal strategies and select external managers that have experienced teams with strong investment discipline through fundamental quantitative and qualitative analysis.
Investing in high conviction portfolios with a quality bias serves as a risk mitigant, eliminating many of the more volatile and momentum-driven positions held in passive strategies. Active management can reduce exposure to overly volatile assets through in-depth research and analysis of the risks associated with each investment, leading to reduced risk and outperformance of the benchmark.
Using an institutional framework to invest in external active managers also allows for economies of scale, such as access to institutional share classes and funds closed to retail investors. We continually monitor and analyze each of the companies and external managers we invest in as a part of our ongoing research process to ensure that all holdings continue to adhere to our investment thesis.
Learn More About
i Morningstar. http://www.wsj.com/articles/the-dying-business-of-picking-stocks-1476714749
ii AMG Funds, Morningstar. https://ip.amgfunds.com/download/active-edge/activeedge-perspective.pdf?elqaid=66&elqat=2&elqTrackId=1d43f40a1fbb472fb05dbd4c25b3eb64
iii SPIVA US Scorecard; https://us.spindices.com/search/?ContentType=SPIVA