In the last few years, passive investment strategies have become much more popular, as evidenced by the massive inflows into more index style vs. active strategies by professional managers.  This appears to be based mostly on a flawed reasoning that cheaper is always better, especially with the push for lower fees by the Department of Labor and recent underperformance of active management vs. major benchmarks.  There are several issues worth considering before we take this idea hook, line and sinker.   First, consider the risk of lack of management oversight from owning a static list of equities from any index like the S&P 500 when in the current market, “yield chasers” are herding like cattle into overvalued high dividend stocks that otherwise could be avoided by risk- focused managers who would prudently steer clear of such securities.   The index is an unresponsive, indifferent list of securities that some committee determined should be included, with no regard for current market conditions, attractiveness of the company itself, pricing or other factors. 

​Secondly and unfortunately, the comparative studies from academic research lump all investment managers in the same sample vs. how the top quartile of managers in the various categories compared.   Our approach at Fleishel Financial Associates is to first identify the appropriate asset allocation and diversification strategy for each client and then pare that with a custom blend of top quartile or decile of professional investment managers that we have researched extensively in each asset class.  Selecting active managers is an art and a science when you consider the myriad of variables to evaluate.  Just a few include; Risk adjusted returns vs. their peer group and benchmark, style consistency, manager tenure, expenses, upside and downside capture, turnover etc. etc.   There are times when we will add a more passive strategy to the mix when we can’t find a compelling manager who is adding “Alpha” or risk adjusted returns in excess of the right-fit benchmark. 

As the chart below shows, top quartile active managers can and have outperformed over time.

                                                                                                                                                                                                                                                        As of 9/30/16
 (Source:  FactSet, Standard & Poor’s, FTSE Russell, J.P. Morgan Asset Management)

Thirdly, certain asset classes like emerging markets or small cap equity tend to be “less efficient” and top managers are more likely to outperform their appropriate benchmark over time since not all categories are similar.   Also, knowing when to fire a professional manager is sometimes harder than hiring a new manager, since temporary underperformance may be a short term phenomenon. Pulling the trigger too soon can often times lead to regret as you see a manager rapidly recover and speed on to the top of their peer group again. 

So, if we can find an active manager that is outperforming his or her benchmark consistently over time, after their fee has been factored in, why settle for a passive strategy that is cheaper but the returns are lower and exposed to more market risk due to an inattentive buy and hold approach?

Past performance does not guarantee future results. Diversification and asset allocation do not guarantee investment returns and does not eliminate the risk of loss.

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Tom Fleishel and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The Russell 2000 index is an unmanaged index of small cap securities which generally involve greater risks. Inclusion of these indexes is for illustrative purposes only. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary.
 
Upside/Downside Capture Ratio – A measure of a manager’s performance relative to the broad market benchmark during
periods of market strength/weakness.
Alpha – Alpha is used as a measure of a manager’s contribution to performance due to security or sector selection. A
positive (negative) alpha indicates a portfolio was rewarded (penalized) for the risk taken above that of the market