The active passive investment debate has been ongoing for many years. However,
listening to our clients, this discussion has again,
become more topical than ever,
probably due to the strong performance and inflows into passive investments.
As a reminder,
active investing involves actively trying to outperform the market by choosing
stocks, bonds, or making decisions based on market trends or analysis.
Passive investing involves buying and holding a diversified portfolio of stocks
or bonds that mirror a particular index like the s and p 500.
The objective of passive investing is to perform in line with the market,
not to outperform it.
There are a number of factors to consider,
and we will focus on two considerations that are most important. Firstly,
the efficient market hypothesis, and secondly, the macroeconomic environment.
The efficient market hypothesis suggests that all publicly available information
about a company or a bond should be reflected in its current share price.
This theory supports passive investing and suggests that it will be very
difficult for a active manager to identify a mispriced opportunity in order to
outperform the market.
This is proven to be true in certain sectors and regions that are highly covered
by analysts such as large companies in America. However,
regions such as emerging markets and smaller companies in America tend to be
less covered by analysts giving it a higher probability for active managers to
outperform the market.
The macroeconomic environment affects among others the relative performance of
larger and smaller companies.
As was evident over the last two decades during the two thousands,
the Russell 1000 equally weighted index with a higher allocation to smaller
companies significantly outperformed the larger companies in the s and p
500 weighted according to company size by 120%.
The opposite was true during the most recent decade when the larger companies in
the same s and p 500 outperformed the smaller companies in the Russell 1000
Index by 20%.
During periods of higher inflation and higher interest rates,
smaller companies tend to outperform, benefiting active management.
In contrast, during periods of lower inflation and lower interest rates,
larger companies tend to outperform,
benefiting those indices weighted according to company size.
At Ston Fleming,
we believe there is place for both active and passive investing in a well
diversified portfolio.
While passive investing is generally associated with lower cost,
active investing may provide greater potential returns in certain market
conditions.
We seek to find top talented active managers that can outperform the index after
their fees. However,
passive investing is a strong alternative when no superior manager can be
identified to fulfill a certain role in a portfolio.