What does active vs. passive investment management mean? How do you define these investment styles?
We get this question or hear this discussed frequently and the answer isn’t as black and white as many think.
Active investment managers are actively seeking to outperform an investment benchmark by making decisions on what assets to hold and at what measures that differentiate them from the benchmark. They believe that through their research and investment processes they can identify assets that are under or overvalued and exploit that pricing discrepancy.
On the opposite end of the spectrum is index investing. What investors typically think of with index investing is an investment fund trying to match a widely known index such as the S&P 500, Russell 2000, or MSCI EAFE. The goal of these investments are to try to match the performance of the index (or benchmark) as tightly as possible.
However, there is also a significant gray area. There are investments that seek to track specific industries, sectors, countries, benchmarks that are created by the manager, and certain risk factors like fundamental indexes. There are also funds that broadly cover asset and sub asset classes, but are not beholden to following an index. While you could argue that these funds are not doing due diligence on specific securities in an attempt to determine whether they should be held in the fund, they also are not reflecting a market neutral allocation to a broad market asset class. These strategies are often referred to as passive which may send a conflicting message to investors given that they are not seeking to track a broad asset class.
Where do we land between active investing, passive investing, or tracking an index? Our approach is to advise on the characteristics that are important to delivering a reliable experience rather than focusing on fund descriptors such as “active” and “passive.” Our experience, and the culmination of extensive research, leads us to believe that the most reliable investments are those that are broadly diversified, very inexpensive, and exhibit very little turnover. Mutual funds and ETF’s that track broad market indexes will deliver an almost perfectly “reliable” experience because they are comprehensively diversified, very inexpensive, and exhibit very low turnover. We believe this is a great start!
Broad market index mutual funds form the core or our client portfolios. But we also use additional funds to seek excess returns or mitigate downside risk. And while these additional funds may not seek to track an index, and therefore fall into the gray area, they are all very inexpensive, broadly diversified, and exhibit very low turnover. We know of very expensive and highly concentrated sector specific index funds whose use would not, in our opinion, deliver a reliable investment experience. Similarly, we are aware of very inexpensive, highly diversified funds that seek to outperform markets that we believe to be highly reliable. We strongly believe in focusing on a fund’s characteristics and seeking those funds that will deliver a reliable experience.
|Index Performance||Sept.||Qtr.||YTD||Trl 1 Yr|
|US Stock (Russell 3000)||2.44%||4.57%||13.91%||18.71%|
|Foreign Stock (FTSE AW ex US)||1.88%||6.01%||21.03%||19.83%|
|Total US Bond Mkt. (BarCap Aggregate)||-0.48%||0.85%||3.14%||0.07%|
|Short US Gov. Bonds (BarCap Gov 1-5 Yr)||-0.34%||0.29%||1.09%||-0.06%|
|Municipal Bonds (BarCap 1-10yr Muni)||-0.51%||0.73%||3.72%||1.00%|
|Cash (ML 3Month T-Bill)||0.09%||0.26%||0.57%||0.66%|
Raffa Wealth Management is an independent investment advisor providing nonprofit organizations, high net-worth investors, and qualified retirement plans with a full range of investment consulting services. We were established to fill the need for transparency, clarity, and vision in the professional management of investment assets. Visit us at www.raffawealth.com