Active v. Passive Investment Management — Does Time Favor the Passive Investor?

Active and passive management refer to two different investment strategies employed in managing mutual funds and exchange-traded funds (ETFs). With so many options of each available to you, naturally there is a debate as to which is the better strategic course for the investor to take. This debate has been going on for years, with passionate advocates on both sides.

Active management involves a hands-on approach where fund managers actively buy and sell securities in an attempt to outperform the market or a specific benchmark index, such as the S&P 500 or the Russell 2000 index. Passive management, also known as indexing, involves constructing a portfolio that mirrors a specific market index. The goal is to match the performance of the chosen index rather than try to outperform it.

S&P DJI (Dow Jones Indices) recently published its 2023 full-year SPIVA U.S. Scorecard. The Scorecard reviews and compares the performance of actively managed funds in different investment categories against their relevant benchmarks. The 2023 Scorecard seems to confirms the findings of past years’ Scorecards – that actively managed funds (equity and fixed) tended to underperform their benchmarks as the investment time horizon lengthened.

Measuring active manager performance, the 2023 Scorecard reports that on a 1-year time horizon, only 6 of 22 equity categories saw a majority of active managers out-perform their benchmark indexes. On a 5-year time horizon, only 1 of the 22 categories had a majority of active managers out-perform the relevant index. Over a 15 year period, not one of the 22 equity categories measured had a majority of active managers beat their benchmark index!

This seems logical. In the short term, an active fund manager can get “hot” (whether by luck or skill) with a few stock picks that can propel the fund to out-perform its benchmark index in a given year. As time goes on the performance of those “hot” managers tends to cool off, causing the fund’s returns to fall back to its historical average (what is referred to as “regression to the mean”). This is one of the reasons why you won’t see actively managed funds that consistently report above-average returns year after year.

Something to consider when deciding between an active or passive investment strategy.

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