The Media’s Incomplete Coverage of the Active/Passive Debate
by AdvisorShares ETF Strategist Roger Nusbaum
Barron’s revisited the debate between active and passive portfolio management with it’s conclusion revealed in the article’s title; Go Active for Bonds, but Index Your Stocks. This is an important issue for market participants to explore and the revisit every so often.
The article works through different market segments looking at where outperformance from active management is most likely to come from. Ultimately there is no single answer to this debate that can be correct for all investors but the framing of this as solely being about performance is incomplete.
A post at The Capital Spectator titled You Can’t Avoid Asset Allocation…Even if You Try included the following;
This is less about hitting home runs vs. avoiding high-risk bets with low odds for success.
To the extent that thought rings true it opens the discussion to include managing a portfolio’s volatility, perhaps its yield and other attributes beyond price appreciation.
All advisory firms have clients that cannot emotionally endure the normal ups and downs of the stock market cycle. Holding on to market cap weighted index funds no matter what may not be ideal for these clients.
All advisory firms have clients that are ahead of where they need to be in relation to their lifestyle and spending needs who may want to focus on preserving wealth. Do people in this situation need 50, 60 or 70% in broad based index funds?
All advisory firms have clients who are most concerned with generating income from their portfolios. Most broad based domestic index funds yield less than 2%.
Of course plenty of folks would look at those three types of client and conclude index fund and that is not wrong, there are no wrong answers, but to the extent some investors are concerned with volatility, wealth preservation and income, one solution like index funds cannot be right for everyone.
The role of an advisor then becomes understanding the needs of their clients and using tools to construct a portfolio suitable for each client. A nervous nellie probably would sleep better with some exposure to funds that reduce volatility through some sort of screening process, long short strategy or that can change its asset allocation.
Some of these same types of tools can also be appropriate where wealth preservation is the priority. People needing more income are likely going to want to allocate to funds with income objectives.
These types of priorities, and plenty of investors have them, are not necessarily consistent with beating the S&P 500 index over some period of time.
To the extent indexing is valid for some investors so too are active strategies valid for other investors. In a future post we’ll look at blending active and passive in a portfolio.