Active vs passive

Active management is much more challenging than passive investing when it comes to beating benchmarks, particularly through the volatile periods seen in the last few years. Active investment management involves manually selecting stocks or bonds that the fund manager thinks will perform best. This compares with passive investing, which replicates and tracks an index that is typically weighted by market capitalisation.

There is a lot of pressure on active funds to perform, and results can be pretty ruthless on the future of the fund. According to a study by SPIVA – a research arm of S&P Dow Jones Indices that studies active management versus benchmark – 20% of US equity funds have either been closed or merged since 2018 because of poor performance.

The same study highlights that 89% of active US equity managers have underperformed over the past five years. This is largely down to a handful of companies excelling, like the previously mentioned Magnificent Seven. If active fund managers don’t include a larger allocation to these few stocks, their fund performance will lag the broad index. This pattern is echoed in the big market regions across the world.

While we’ve taken a positive stance towards passive investing for many years, we think the tide is turning and there are better prospects for active equity investing in the future.

Firstly, major stock indices have become very concentrated. For example, the Magnificent Seven stocks account for 30% of the S&P 500. These stocks have premium valuations that leave little margin of error on future earnings. In contrast, the remaining 493 stocks in the index are cheaply valued and should have a better opportunity to outperform. This is where active management could provide optimal returns by picking the stocks most likely to succeed.  

Secondly, the fees associated with active management are usually more expensive than their passive counterparts. However, research shows that some institutional managers, like large pension plans and sovereign wealth funds, are beating benchmarks and at a lower fee. With active management falling out of favour for many asset management firms, fees are declining in order to maintain business.

In our eyes, this makes active management an appealing strategy in the current environment.