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Choose Passive Over Active Stock Fund Management? It Depends

Debates have raged for decades about the relative advantages and disadvantages of active stock fund investing versus passive investing. While interesting, however, it has always been relatively inconclusive. That is, until now, at least in the eyes of the majority of investors.
Debates have raged for decades about the relative advantages and disadvantages of active stock fund investing versus passive investing. While interesting, however, it has always been relatively inconclusive. That is, until now, at least in the eyes of the majority of investors.

Debates have raged for decades about the relative advantages and disadvantages of active stock fund investing versus passive investing. While interesting, however, it has always been relatively inconclusive.

That is, until now, at least in the eyes of the majority of investors.

You need look no further than the endless turf battles between The Vanguard Group and Fidelity Investments. For years, Fidelity, the biggest actively managed mutual fund company, raked in more money. Now Vanguard, the biggest passively managed mutual fund company, is the kingpin. At the end of 2015, Vanguard had $3.1 trillion in mutual fund assets under management, compared to Fidelity’s $2 trillion And Vanguard funds posted record industry mutual funds flows in 2014, as well as 2015.

For a copy of a strong white paper that delves into the important nuances of this timely subject, call Annuity FYI at (866) 223-2121 or email us by clicking on Ask Annuity FYI by Email.

This was the case, moreover, even though Fidelity’s U.S. stock funds topped roughly 75 percent of their peers over the past one-, three- and five-year periods ended in 2015.

Yet this doesn’t mean you should shift from actively managed mutual funds – if that is where some of your investment funds currently reside — to passively managed funds, according to a recent white paper published by Baird Research. In fact, both approaches are valid. Each offers advantages. Passive funds offer lower costs, more tax efficiency and the unbridled embrace of market efficiency. Active management offers the potential for above-market returns (although it may wind up being below-market returns.)

Market efficiency is the degree to which stock prices reflect all available information. In a perfectly efficient market, all stocks are precisely valued and no active manager can outperform the market. On the other hand, if the market were completely inefficient, nearly all active managers would beat the market. The truth, predictably, lies somewhere in the middle, and that is what the Baird white paper focuses on. It probes where one approach is often better than the other.

Based on Baird’s extensive research, one key conclusion fundamentally boils down to this: You’ll probably do better with a passively managed core big cap stock fund and better with an actively managed small cap value fund.

Here are the particulars. The media large-cap core fund outperformed its benchmark only 20 percent of the time in various one-, three- and five-year periods. By contrast, the median small value fund beat its benchmark 67 percent of the time in these periods. So in the latter arena, you’re probably better off with a good actively managed fund.

Baird also notes that investors may fare better in even actively managed diversified big cap funds if they are top-quartile performers. Their performance is materially superior. This decision is a closer call, however. This is because it’s tough for a manager to maintain this ranking over time, particularly in a more efficient investment arena, although some Fidelity funds and others have managed to do so for a number of years.

For a copy of a strong white paper that delves into the important nuances of this timely subject, call Annuity FYI at (866) 223-2121 or email us by clicking on Ask Annuity FYI by Email.

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