Contributed by: Abigail Fischer
Let’s begin with a refresher course! What is active and passive management?
Usually, a passive management strategy closely mirrors the performance of large indexes and benchmarks. Whereas, investment professionals hand-pick securities in an attempt to outperform or adjust the risk of those same indexes and benchmarks in an active management strategy.
Investment professionals who praise passive management strategies were further convinced of their validity when indexes and benchmarks outperformed the active management space, yet again for many asset categories and managers, in 2018 and 2019. One challenge active strategies must overcome is their fee. The fee for active management chips away at performance beyond benchmarks.
So why would you ever choose active management?
Active strategies are often perceived to be “advantageous” because of their agility to trade stocks or bonds as they see fit. They may also be accountable to keep risk in line or lower than their peers or benchmarks which could be appropriate for many investors.
A Case Study Of Our Research
The Center’s Investment Department research on the fixed income space found an interesting correlation. Just as markets are cyclical, active management tends to outperform passive management at some very specific points in the economic cycle. The low-interest rate environment, along with the dislocations in the pricing of bonds encapsulating 2020 fixed income markets, diminishes passive investors’ success in the broad fixed income market. The chart below shows just how muted annualized returns, punctuated by very low yields now, have become in some of the largest fixed income categories on a more recent basis versus what occurred in the last decade; this environment has set the stage for active managers to shine. When interest rates are low and bonds aren’t trading consistently across asset classes, a manager with flexibility is more likely, through careful research, to identify and exploit mispricing. When interest rates are so low, even small successes can contribute heavily to returns relative to benchmarks.
What does this mean for portfolios now?
When interest rates will increase is purely a guessing game, could be next month or next year. In the meantime, we strive to take advantage of the possibility that active fixed income managers can find risk-adjusted returns more favorable than passive management fixed income returns. While this is just an example of one asset class, the Center’s investment team applies this same theory in researching all asset classes. This results in a dynamic mixture of both active and passive investment strategies in portfolios. Have more questions? Don’t hesitate to reach out!
Abigail Fischer is an Investment Research Associate and Investment Representative at Center for Financial Planning, Inc.® She gained invaluable knowledge as a Client Service Associate, giving her an edge as she transitions into her new role in the Investment Department.
Views expressed are those of the author and not necessarily those of Raymond James and are subject to change without notice. Information provided is general in nature, and is not a complete statement of all information necessary for making an investment decision, and is not a recommendation or a solicitation to buy or sell any security. Past performance is not indicative of future results. There is no assurance these trends will continue or that forecasts mentioned will occur. Investing always involves risk and you may incur a profit or loss. No investment strategy can guarantee success.