A Balanced Introduction to Active Management
July 8, 2024
Have you ever noticed that every opinion piece on active management starts the same way?
First, the article talks about Sharpe’s “arithmetic of active management” and its “proof” that active management is doomed to underperform. It then summarizes the latest SPIVA or Morningstar Barometer report – which always show that active management has underperformed. It then moves on to complain about the high cost of active management.
Oddly enough, even fans of active management feel compelled to use this introduction.
But it’s time for a new way of presenting active management to clients, argues an article in the May/June issue of Investments & Wealth Monitor. The article, which is titled, “Beyond the False Dichotomy of Active Versus Passive,” is authored by Apurva Schwartz, portfolio specialist at Harding Loevner and Chair of the Active Managers Council Thought Leadership Council.
Schwartz argues that the classic introduction to active management perpetuates myths about active management, and she makes suggestions about how this introduction should be reframed to provide a more accurate portrayal of active management’s value to investors.
As to Sharpe’s theory, Schwartz explains how other models may be less intuitive but more realistic. For example, the Grossman-Stiglitz equilibrium posits that active and passive should be equilibrium, a theory that is well-supported by academic research.
And active management’s performance? Active managers can and do outperform, Schwartz asserts, and investors can identify outperforming managers in advance. She goes on to explain why and how the active-passive “scorecards” from SPIVA and Morningstar present an overly negative picture of active management’s performance.
With regard to cost, Schwartz notes that active managers are often providing additional benefits that support high fees. They may provide access to markets where indexing is difficult or customization to meet investor needs.
Schwartz concludes that both active and passive are important to both the markets and investors. Investors should consider both cost and benefit but may often find that combining active and passive in a portfolio is optimal.
In sum, active management is an important component of a complete financial plan, and the industry needs to introduce it in an appropriately positive way.