The previous decade has been an environment structured so that passively managed funds typically outperformed actively managed ones. However, that may be shifting as COVID-19 has created levels of volatility and uncertainty that haven’t been seen since the 2008 financial crisis.
The roughly ten years between the financial crisis and the onset of the COVID-19 pandemic saw interest rates that hovered at record lows as well as a policy of quantitative easing in which central banks bought longer-term securities to encourage investment and lending, as well as increase the money supply, reported Financial Times. That, coupled with fairly positive overall growth, created an environment ripe for passively managed funds to outperform their benchmarks, as there was extremely low volatility.
Active funds typically outperform their benchmarks best when there is volatility, such as what is being seen now, and haven’t been given the opportunity to really showcase their full potential in the last decade. With concerns of Delta and other COVID-19 variants creating uncertainty in the global economy, shuttering recovery and reopening for economies in different regions and to different degrees, the markets are increasingly variable and difficult to predict.
In short, the pandemic is creating a scenario in which actively managed funds could potentially enter into the fray and emerge as outperformers while passively managed funds struggle to meet benchmarks. However, it isn’t just in the short term that active funds can exhibit strong performance, but the timeline is on a much larger scale.
A recent Vanguard study analyzed 2,500 actively managed funds that are domiciled in the U.S. over a 25-year time period. The study found that over time increments in one-, three-, and five-year periods, the outperforming active funds had sharp dips compared to their benchmarks and passive peers.
Additionally, 80% of actively managed funds that outperformed had at least one five-year stint of being in the bottom quartile of all funds and experienced a two-year continuous fall in value over every ten-year period, with at least one fall of 20%.
A Morningstar study highlighted that over a 100-year period of time, even the best active management funds would underperform compared to their benchmarks for twenty of the years in question.
It’s a lot of time to underperform, but those times are typically seen in periods of low volatility and steady growth. Times of volatility and uncertainty are when active management really shines, and despite underperforming potentials, the vast majority of the time (four-fifths of the time to be exact, according to Morningstar) active funds perform or outperform their benchmarks.
“We have long held the view that active versus passive is a needless debate for fund investors, and they should choose both. Of course, investors in active funds should note that they will need to have the patience to withstand potentially lengthy periods of underperformance on the way to long-term wealth generation. This is what we refer to as noise-cancelling investment,” said John Husselbee, head of the multi-asset team at Liontrust.
T. Rowe Price believes in the difference and benefits to active investing and active management. The firm currently offers five actively managed ETFs for investors that are looking to invest in an environment of record IPOs that benefits stock pickers. The firm brings a bevy of experience and research to its products, with portfolio managers averaging over 20 years in investing each, as well as over 400 investment professionals dedicated to researching companies within ETFs.
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