Active is besting passive, so now what?

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Articles are starting to show up this year to advise investors that active management is beating passive management. More and more are coming to light as the year goes on. With the recent rush to invest in cheaper, passive vehicles over the past number of years we have now begun to see an outflow from some of the passive mandates. as Josh Brown commented in his blog this morning "A lot of newly passive, patient money turned out to not be all that patient after all." His blog by the way, is a good read and is both humorous and informative even if I don't always agree with his viewpoints. You can read his full post from last week here. He noted today that active investments are ahead of passive investments and that growth strategies are beating value strategies over the first half of 2015. To support this he uses this graph:

 

Interestingly though, the S&P 500 is up about 2.96% in the first half of 2015, so we aren't seeing enormous outperformance at this point (on the magnitude of 0.25%). I'm also not sure that this is accurate because I cannot discertain whether the graph includes fees or not; clearly if that is pre-fees then the active strategies are not giving you much for outperformance at all. Another auspicious consideration here is whether the active funds can show consistent outperformance in better years for the indexes. Since 1970 the S&P has shown returns that were positive and below 3% only twice when you include the dividends. I suppose what I'm suggesting is that this outperformance over the shorter term could be an anomaly, or could be just part of the normal business cycle, but regardless of why the main question is how consistent will it be? In Canada, the market is virtually flat this year (see below) and the Dow Jones is in roughly the same shape. The NASDAQ on the other hand is up almost 9% this year, so it's fairly easy to see where active managers are generating those S&P 500 beating returns from.

 

 

As I've noted on my site, my investing style uses a sort of modified Treynor Black model. The model isn't really passive, although I do use indexes a fair amount. The single securities layered on top are largely value stocks and as a result in a year like this, you might wonder about the performance. The portfolios I use are definitely diverse and built for the long-term however. As Norman Rothery noted in his recent column in the Globe and Mail though, "...diversified portfolios often sail through storms in reasonably good shape. Sure, it can be hard to watch them slip underwater for a few years. But they'll likely emerge and grow again."

 

While the temptation at this point might be to abandon a passive strategy or adapt to take higher stakes at this point in the cycle, that could be unwise. Using a diverse, well thought out strategy is probably the safest way to behave and if nothing else it’s a lot less of a knee-jerk reaction to short term moves.