Many investors are faced with the classic “active versus passive” management debate when it comes to choosing strategies. Passive managers simply mirror an index and make no other adjustments, while active managers can be more proactive and respond to varying market conditions.
The following is the first of six reasons why investors should emphasize active investment management.
(1) Markets Look Forward, Indices Look Back
The primary argument for active management is that markets look forward and indices look back. Passive managers do not have the ability to react and make changes to the portfolio (beyond index adjustments) because they blindly follow an index, while active managers essentially shape the value of a security by trading on any new information (e.g., earnings news, acquisitions).
The chart below tracks the flows of S&P 500® Index sector weightings since 1997. Imagine holding (without a chance to adjust) a significant weight of financial stocks heading into the recent Financial Crisis, being loaded with technology stocks leading into the tech bubble, or even saddled with energy stocks splashing into the early 1980s oil crisis (not pictured). An active manager would have had the opportunity to make changes to the portfolio in such markets.
- While passive managers simply mirror positions in an index or benchmark and make no other adjustments, active investment managers can be more proactive and respond to varying market conditions.
- You could say that markets and active investors are focused on the future and passive investors represent what has already happened (as the weights of individual securities are shaped by previous prices).
- We believe the ability for active managers to read and react is quite valuable and is a key strategic advantage over passive management.
- Active managers are searching for the winners of tomorrow whose growth potential is not reflected in current stock prices.
- Active managers have the opportunity to anticipate market changes or events and are searching for the winners of tomorrow whose growth potential is not reflected in current stock prices.
Next week, we’ll discuss historical active and passive performance.
Part II: Proof that Active Has Done Better than Passive
Active investment management
Active investment management strategies are the opposite of passive investment strategies. Active portfolio managers regularly take investment positions that clearly differ from those of the portfolio’s performance benchmark, with the objective of outperforming the benchmark over time. In addition to the upside potential of outperforming the benchmark, there’s also the downside possibility of underperforming the benchmark.
Passive investment management
Passive investment management strategies are the opposite of active investment strategies. Passive strategies are designed to mimic market benchmark indices and minimize trading costs.
Material presented has been derived from industry sources considered to be reliable, but their accuracy and completeness cannot be guaranteed. Past performance is no guarantee of future results. This information is not intended to serve as investment advice.
Opinions expressed are those of Scott Wittman, CFA, CAIA, and are no guarantee of the future performance of any American Century Investments portfolio. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.