Active and Passive Investments Can Work Together

“The trend so far has been going one way or the other—either all actively managed funds or all passively managed funds,” Dave Mazza, co-author of a paper from State Street Global Advisors (SSgA), told PLANSPONSOR. However, he says, by having a combination of actively and passively managed funds in a retirement plan’s investment lineup, investors can have the best of both worlds.

“You can go from asset class to asset class, looking for which funds have done well and which have done poorly,” says Mazza, head of ETF Investment Strategies for SSgA, based in Boston. “For example, plans might choose some passively managed funds, such as large-cap equities, that have done well, and some actively managed funds, such as emerging markets, that have also done well.”

In the paper, “Leveraging the Best of Active and Passive Investment Approaches,” Mazza and his co-author, Thomas F. Guarini, product specialist for SSgA, observe that sometimes managers of actively managed funds can lag behind benchmarks. In terms of what due diligence steps plan sponsors can take in choosing such a fund, Mazza says, “Look at what the investment philosophy is. Look for the competitive advantage of a fund, despite its active or passive label. Also, funds and their managers may do better in certain scenarios, like when there is volatility in the market.” All of these elements, he says, need to be factored in.

Mazza and Guarini highlight this in the paper, saying investors should be cognizant that certain investment styles come in and out of favor depending upon underlying market conditions. They cite how certain active managers do well in trending markets, while others may do best when markets reward companies that have been the most beaten up.

As to how to integrate actively and passively managed funds into an investment lineup, the authors recommend considering factors like cost. In the paper, they point to the lower cost of passive funds being an advantage if the investor if they intend to move frequently in and out of positions with higher turnover strategies. The authors also point out passive funds may do a better job of augmenting longer-term positions with more tactical investment ideas. Active funds may, on the other hand, may be better suited to take advantage of a successful manager when their approach is most in favor.

The authors conclude passive funds are no longer just a cost-effective alternative to active funds. They can serve as both a replacement and complement to active funds. The approach of using both types of funds in an investment lineup, they say, harnesses the best of passive and active and can help build the most cost effective, resilient and robust portfolios possible.

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