The Cyclicality of Active and Passive Investing
September 11, 2018
Insights from Hartford Funds on the cyclical nature of active and passive investing
Offering evidence to further challenge the “Conventional Wisdom,” commentary from Hartford Funds earlier this year uncovered some surprising statistics: From 2000 – 2009 active outperformed passive 9 out of 10 times. During the decade before that, passive outperformed active seven out of 10 times. And over the course of the past 32 years, active outperformed 15 times, while passive outperformed 17 times. Such data provides the basis for the main premise of the piece that “the performance of active and passive management has been cyclical, with each style trading periods of outperformance.”
As Hartford Funds writes, simply because one style of investing has come into favor does not mean others are going the way of the dodo. “Market corrections are a regular and unavoidable part of market cycles. Active management has typically outperformed during market corrections because active managers have captured alpha as the market recovers. The nearby performance comparison table from Hartford Funds illustrates this.
Most investment professionals agree that deploying a mix of active and passive is optimal and that a portfolio lacking an active investment strategy, particularly during market corrections, could be problematic. The report cites, “When bull markets inevitable turn, passive managers could be left holding stocks and sectors with poor fundamentals and inflated valuations. Meanwhile active managers have the ability to mitigate risk by reducing exposures to expensive areas that will be hit hardest, and conversely, increase exposure as sectors or asset classes recover to capture upside as the new market cycle begins.”
Perhaps the lesson to be learned is that, “just when it seems that active or passive has permanently pulled ahead, markets change, performance trends reverse, and the futility inherent in declaring a “winner” in active vs passive is revealed anew.”
Hartford Funds also encourages readers to beware of recency bias, “or the tendency to believe that recently observed patterns will continue into the future.” True, passive strategies have outperformed active strategies in four of the last five years. But a longer term look at performance shows that “active and passive have traded the lead in performance over time like two evenly matched racehorses.”