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The case for active funds amid volatility

Kyle Tetting explains why the timing is right for investors to take a careful look at actively managed mutual funds to mix in with low-cost passive index funds. Kyle spoke with Joel Dresang in a Money Talk Video. A transcript of their conversation follows.

Joel Dresang: Kyle, after an extraordinarily calm year, stock volatility is back. So now that we’ve got stock prices going up and down and up and down, and considering we’re in the latter innings of the business cycle, let’s talk about actively managed mutual funds.

Kyle Tetting: Joel, in 2017, the markets all rising pretty drastically and everything largely rising in tandem. And what we saw is the very low-cost passive indexes getting a lot of investment simply because they’re low-cost, and that’s a great way to invest, when everything moves together. But, you know, as you mentioned, 2018, seeing some volatility return, I think the story is a little bit different now.

Joel:  What about that low cost of indexing?

Kyle: You know, obviously you get a very particular approach to investing with index funds, where you’re buying a very passively managed portfolio of stocks that tracks some underlying index, typically something like the S&P 500 or the total stock market. And again, that’s really great when everything is going up in tandem, but as we’ve seen recently – and as we see, especially in the latter stages of the business cycle – there’s other ways to go about investing.

Obviously, cost does matter. And what we want to do is make sure that we’re finding those investments that offer the best bang for the buck. So, you’re not just trying to buy cheap, because sometimes you do get what you pay for. But cost is a very important part in the overall investment picture.

Joel:  Why is this a particularly important time to talk about active management?

Kyle:  Joel, go back to last year, and you have all those stocks largely moving in tandem higher. You had correlations near one among stocks. But that’s changed in 2018. We’ve seen stocks start to diverge a little more. 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 right now.

And so, a great example is value vs. growth stocks. The idea of traditional value has changed a little, but the old value indexes still rely on those traditional metrics. And so, you’ve got value managers out there doing things that are very different than what they would have done traditionally. A great opportunity to take advantage of active management.

Joel:  So, if active managers can add value, why is the average active fund still trailing the benchmarks?

Kyle:  There are a lot of knuckleheads out there, people that probably shouldn’t be in the investment business, or at least shouldn’t be running the funds they’re running. You know, maybe they lack the experience. Maybe the philosophy that they have for investments just isn’t something that works anymore.

We try to avoid, obviously, those knuckleheads, and it’s typically pretty easy to do because you need to understand what an investment manager is trying to do, you need to understand why that works, and then you bring in that cost piece as well. You want to try to find investment opportunities that are lower cost. It does matter. Cost is a very important factor, but sometimes you get what you pay for.

Joel: And what about the active manager’s role in managing risk?

Kyle: One of the big pieces of active management is the ability not just to target return. 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.

Joel: What should investors be doing?

Kyle: You know, I think investors need to remember that it’s not just about active or passive, that those pieces of a portfolio can work together, to really provide an investor both low cost and some actively managed opportunities. But ultimately in the active management piece, it’s about understanding what a manager does, about making sure that they can do that successfully and understanding why it works. And if you really kind of put all of those pieces together, you can get an outcome that’s far more successful than simply passive investing alone.

Kyle Tetting is director of research and an investment advisor at Landaas & Company.
Joel Dresang is vice president-communications at Landaas & Company.
Money Talk Video by Peter May and Jason Scuglik

Learn more:
When Should I …consider actively managed funds? 
When Should I …consider passive index funds?
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
A place for active management, a Money Talk Video with Marc Amateis
Talking Money: Active management, a Money Talk Video with Kyle Tetting
Correlation: How investment balance can shift, a Money Talk Video with Kyle Tetting

(initially posted June 15, 2018)

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