Passive vs. Active Investing Debate Renewed in Post-COVID New Normal

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The alternative investments landscape is one that has always been in a state of continuous flux and innovation. The COVID-19 pandemic, in many ways, intensified the speed of ongoing change. It also renewed our industry’s debate over active versus passive investing strategies and which one makes more sense for investors in the current market environment.

Investopedia offers a great explainer on the key differences between the two strategies in a blog post titled: “Active vs. Passive Investing: What’s the Difference?” In their Investment Strategies and Portfolio Management program, Wharton faculty teaches about these differences in depth. Here is their breakdown on the key strengths of each:

Passive Investing Advantages

Ultra-low fees: There is no stock picker to be paid in this strategy. Passive funds simply follow the index they use as their benchmark.

Transparency: What you see is what you get with an index fund, which means investors always know what stocks or bonds are included in the mix.

Tax efficiency: An index fund’s buy-and-hold strategy doesn’t typically result in a massive capital gains tax for the year.

Active Investing Advantages

Flexibility: Because active managers, unlike passive ones, are not required to hold specific stocks or bonds.

Hedging: The ability to use short sales, put options, and other strategies to insure against losses.

Risk management: The ability to get out of specific holdings or market sectors when risks get too large.

Tax management: Including strategies tailored to the individual investor, like selling money-losing investments to offset taxes on winners.

We’ve Been Here Before

Passive investing remained in the limelight in recent years – especially before the pandemic — as it outperformed active strategies in many instances. In 2019, for the first time, assets of U.S. index-based equity mutual funds and ETFs surpassed actively managed funds in what Bloomberg called the “End of an Era.” However, don’t forget that the “end of an era” is also just a way of saying welcome to the new beginning.

According to Wharton’s website, well-known finance professor Jeremy Siegel “is a strong believer in passive investing, but he recognizes that high-net-worth (HNW) investors do have access to advisers with stronger track records. In that case, a management fee is not as burdensome.”

This especially might be the case in the post-COVID world, according to Cory Lester of Morgan Creek Investments, which of course falls in the active end of the spectrum. During a webinar in January hosted by real estate private equity firm Excelsior Capital, Lester said the following regarding his current outlook on active vs. passive:

The way averages work – you have to spend just as much time below as above. We’ve been in [an] … extraordinary period of equity market outperformance versus the long-term average over the last handful of years. It is human nature that people buy what they wish they would have bought, and sell what they are going to need. We think that smart, high-quality, active investing that can protect capital in volatile environments and when equities aren’t rocketing higher will be key to outperforming and providing some downside protection over the next part of the cycle.

This makes sense, given that data from Morningstar and Hartford Funds that goes back 35 years shows that active and passive investing trends indeed are cyclical, trading places in terms of their outperformance over large periods of time. As one fund manager told ThinkAdvisor in May: “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.”

Our AXIS platform can help you stay in front of the investing trends, shifts and reversals. We believe transparency, and engagement, can lead to well-informed alternative investment decisions.