Active management is an investing strategy in which investment professionals strive to outperform specific benchmarks. Passive management is an investing strategy that attempts to mirror the return pattern of a specific benchmark.
Can active managers actually outperform benchmarks? The debate between active and passive management is not new, but in my research on these two very different management styles, I uncovered something that actually caused my jaw to drop. I found research from Vanguard showing that just as markets are cyclical, there are cycles to management. Sometimes active management wins, but passive management outperforms at other points, as shown in the chart below. Over the past 10 years, every time interest rates went up (the orange line), the percent of active fixed income managers that beat their index also went up (the yellow line).
Benchmark used: Barclays U.S. Government Bond Index
Over the past 10 years (and looking beyond this chart, the past 30 years) interest rates have been on a downward march, making it difficult for active managers to add value over their fees for a very long time. There have been brief periods of rising rates though as shown in the chart above.
What does this mean now for portfolios now?
Interest rates are near 30 year lows. While I don’t believe they will go much lower they should soon start to trend upward…though it could be tomorrow, next month or a year from now. A bet on passive investing in fixed income, at this point, is against the odds in an environment with such low and potentially increasing rates. Active managers may have their chance to shine after what has seemed like a period of prolonged underperformance to their benchmarks.
Angela Palacios, CFP®is the Portfolio Manager at Center for Financial Planning, Inc. Angela specializes in Investment and Macro economic research. She is a frequent contributor to Money Centered as well asinvestment updates at The Center.
Source: “The Active-Passive Debate: Market Cyclicality and Leadership Volatility”, Vanguard Research July 2014
This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Any opinions are those of Center for Financial Planning, Inc. and not necessarily those of Raymond James. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Every investor’s situation is unique and investors should consider their investment goals, risk tolerance and time horizon before making any investment decision. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Indexes are unmanaged and cannot accommodate direct investment. C14-027422