October 2018 | Public Version

In our last newsletter, we argued that we may be in a passive investing bubble that continues to grow as part of a self-reinforcing cycle: combined with a race to the bottom for fees, money continues to flow into passive strategies thus boosting returns and attracting more flows into the strategies. One consequence has been a common misunderstanding that active management is dead. In this newsletter, we analyze the current market environment and present the case for active management as a long-term investment strategy. We conclude that unconstrained active strategies, which allow managers to pursue returns across many equity styles, have the potential to outperform in the present environment and are also the future of active management.

There is a field of thought within the financial industry that suggests that active money management is dying. Moreover, flows into passive funds have grown by 25% annualized since 2011, culminating in $692 billion flowing into passive funds in 2017. The creation of this potential “passive investing bubble” has been driven by interest rates held exceptionally low for a prolonged period (thus making stocks appear relatively inexpensive) and a race to the bottom for fund fees.

While some investors are asking why actively managed strategies have underperformed, we believe the question should be is your active manager constrained? Many times, portfolio managers are trapped within a Morningstar category. The inability to deviate can result in managers underperforming when certain categories are lagging.

Based on active share data as of 12/31/2016 from sample of 1,384 funds from ActiveShare.info and Vanguard Mutual Fund and ETF Screener. High active share is represented by funds with over 80% active share. Morningstar category returns from Zephyr StyleADVISOR.

Past performance is no guarantee of future results. The referenced indices are shown for general market comparisons and are not meant to represent any fund. Investors cannot directly invest in an index; unmanaged index returns do not reflect any fees, expenses or sales charges.