A great debate in the world of investments is whether to employ active management or passive management in your investment portfolio. Active management involves an investment professional or investment team making buy, sell or hold decisions for the portfolio, while passive management (aka “indexing”) involves the formulaic replication of a pre-determined benchmark.
Actively managed portfolios have many benefits, including:
- The ability to outperform benchmarks. Active managers use a variety of tools, from quantitative and qualitative analysis to industry experience, in their efforts to outperform the market. The more different a strategy looks from a benchmark, the more opportunity to outperform (and underperform), so selecting a manager with a solid foundation, long track record and replicable strategy is paramount.
- Actively managed portfolios can be customized. Whether you have views that preclude certain companies, tax considerations that seek to limit taxable events or other individual considerations, many investors benefit from granular management of their portfolio.
- Actively managed portfolios are diversified in a conscious way. While owning a fund that tracks the S&P 500, and therefore owns slices of 500 stocks, there is considerable concentration in certain securities. For example, on May 31, 2023, the S&P 500 ETF (SPY) had an 8% position in Apple, 7% in Microsoft and 4% position in Alphabet. Nearly one third of the fund is invested in the Information Technology sector. Those weights might not be a bad thing but owning 500 stocks and having half of the total portfolio’s value invested in just 36 stocks gives a false sense of diversification—the spreading of risk.
- Individual stock opportunities have arisen frequently in our 45+ years of investing experience. We believe the ability to take advantage of those opportunities is a key reason to favor active management over passive.
- Active management can offer a steady hand in times of uncertainty. Data from DALBAR’s Quantitative Analysis of Investor Behavior (here) shows investors can be their own worst enemy. While relatively low fees for index funds offer an attractive alternative to more-expensive active funds, the propensity to panic can lead to bad investment outcomes. DALBAR’s Chief Marketing Officer, Cory Clark noted, “Investors’ main concern should be making sure they are not adding to losses through an irrational attempt to avoid them.”
While some investors may find index funds suit their needs, there remains a large proportion of investors that can benefit from active portfolio and wealth management. In the 680th edition of The Prudent Speculator, Editor John Buckingham wrote, “Patience is paramount, but we have steady hands and a very long-term time horizon, while we like the inexpensive valuations and solid income (12 times NTM earnings and 3.1% yield for TPS) on our portfolios. Noting that Value Stocks and Dividend Payers historically have enjoyed the best long-term returns, we find added comfort in the Robert Louis Stevenson quote, “Don’t judge each day by the harvest you reap but by the seeds that you plant.””