Staying active as conditions change
As market volatility reemerges and the record economic expansion eventually winds down, investors should check their portfolios for actively managed funds.
Active management offers flexibility not allowed in less-expensive index-tracking passive funds. The latitude that active managers have for managing risk as well as for adjusting to market fluctuations and changes in the business cycle make such funds a valuable component in a balanced investment portfolio.
“Investors should revisit the importance of active management and what role it plays in their portfolio,” says Paige Radke. “There are a couple of things that make now the right time to have some active management in your portfolio.”
First, there’s volatility. Heightened volatility, including recent wild swings up and down in stock prices, can separate the overpriced stocks from the bargains, according to Kyle Tetting.
“And that’s where active managers can really shine, step in, take advantage of some of that opportunity and really build a portfolio that doesn’t just look like the index but that represents the opportunity that’s out there,” Kyle says in a Money Talk Video.
Second, the end of a business cycle also presents opportunities for active managers.
“At the start of a business cycle, the market has an all-boats-rise mentality, which causes everything to move up together,” Paige explains. But at the end is when active managers really earn their fees, ferreting out the best buys.
“At that point,” Marc Amateis says in a Money Talk Video, “certain stocks are fully valued, certain sectors are fully valued, and active management can help find those sectors and those stocks where you still have room to run.”
“They do what they do on a daily basis,” Art Rothschild said in a recent Money Talk Podcast. “They’re evaluating companies and the prospects for those companies being prosperous, regardless of what happens going forward.”
Also, importantly, active management is charged with controlling risk in investments.
“So many investors focus in strictly on performance. You’ve got to look at the risk you’re taking,” Marc says. “We know there are a lot of good actively managed funds out there that have shown over time that they consistently beat the indexes, even after their expenses, and they do it with lower risk.”
Kyle agrees: “It’s great to say you can beat the benchmark or you can beat the index, but active managers often can take significantly less risk than the benchmark, while still trying to achieve like-benchmark returns.”
Active management isn’t limited to the stock side of a portfolio.
“The active versus passive debate tends to focus more on stocks than bonds,” Paige says, “but active bond funds also play an important role.”
Active bond funds outperformed their passive counterparts over the past one-, three-, five- and 10-year periods through the end of 2018, she notes.
Active bond fund managers have three main tools that give them more flexibility to adjust their holdings and add to returns, Paige explains:
- Active bond managers can track and adjust for changes in the Federal Reserve’s target interest rate, allowing them to increase duration when interest rates are falling and to shorten duration when rates are rising.
- Second, active bond managers can control for holding periods and sector exposure. Most indexes simply buy bonds at issue and hold them until maturity. That means investors can plan on the interest being paid out, but the funds will be more sensitive to price movements. Active managers, on the other hand, can find advantageous entry and exit points for bonds, allowing them to buy at a discount or sell at a premium when interest rates are falling.
- Active bond fund managers also can control for risks from default, which becomes more important in a falling rate environment. Falling rates imply a slowing economy, raising the risk that companies won’t be able to pay back their bonds. Active managers can review and adjust their bond holdings to control the risk of default.
Edited by Joel Dresang, vice president-communications at Landaas & Company.
When Should I …consider actively managed funds?
When Should I …consider passive index funds?
The case for active funds amid volatility, a Money Talk Video with Kyle Tetting
A place for active management, a Money Talk Video with Marc Amateis
Sorting through investment fund managers, a Money Talk Video with Kyle Tetting
What You Need to Know About the Passive vs. Active Management Debate, from the Financial Industry Regulatory Authority
“Active vs. Passive Management” in Mutual funds, from the Financial Industry Regulatory Authority
(initially posted August 27, 2019)
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