Active vs. Passive: The Age-Old Debate
The debate on the benefits and shortcoming of active versus passive investing rages on! This paper explores where we are in the active-management cycle and why it may be shortsighted to move away from active management at this time.
Many active managers have disappointed in recent years. Some investors now believe that “going passive” will protect them from underperformance and the perceived risks of active management. However, this may not be the right time to make an active decision to go passive. In this paper, we discuss: the cyclicality of active management -- history shows that out-of-favor periods were followed by strong reversals; active management results vary with the direction and magnitude of market performance; and although passive management captures the upside movements of stocks, it also assumes all of the downside risk. Consider: If a portfolio declines in value by 50%, it takes a 100% rebound just to break even! By not realizing all the downside, skilled active managers tend to outperform over the long term regardless of the cyclical headwinds in sharply rising markets. We also discuss an active management strategy that ideally would self-adapt to changing market conditions.