activeVPassiveProsAndCons
The Pros and Cons of Passive Management
Ever since the introduction of passive index funds in the mid-1970s, there has been an ongoing debate over the merits of active versus passive management of pension fund assets. Each year articles chronicle the relative rise and fall in popularity of each approach to portfolio management. The advantages and disadvantages of each approach vary with the size of the portfolio as well as with the characteristics of the asset classes. In fact, there may be a place for both forms of asset management in a single investment portfolio.
Active managers attempt to add value over the market-related returns through security selection and/or market timing by relying on security analysis and investment research. Passive management can take on many forms, from immunized fixed income portfolios to enhanced index funds. The basic features common to each passive approach are an alignment of the portfolio to reduce risk relative to a segment of the market, and a reduction in the research inputs needed to construct the portfolio. Pure passive portfolios are managed without placing valuation judgments on the individual assets, economic sectors of the market, or the market as a whole. Studies of manager performance and academic research on the efficient market hypothesis, as well as increased cost consciousness, have led to the acceptance of passive management as a viable alternative to active management.
Historical Median Manager Performance
Historical evaluation of active managers’ performance relative to the market indicates that within some market segments, it has been difficult for active managers to beat the index consistently. Exhibits 1 through 4 show cumulative returns for median active managers relative to a market index that is representative of the returns from passive management. These graphs illustrate the trends of the median active manager’s performance over time. A positively sloped line indicates that the median active manager is
Ever since the introduction of passive index funds in the mid-1970s, there has been an ongoing debate over the merits of active versus passive management of pension fund assets. Each year articles chronicle the relative rise and fall in popularity of each approach to portfolio management. The advantages and disadvantages of each approach vary with the size of the portfolio as well as with the characteristics of the asset classes. In fact, there may be a place for both forms of asset management in a single investment portfolio.
Active managers attempt to add value over the market-related returns through security selection and/or market timing by relying on security analysis and investment research. Passive management can take on many forms, from immunized fixed income portfolios to enhanced index funds. The basic features common to each passive approach are an alignment of the portfolio to reduce risk relative to a segment of the market, and a reduction in the research inputs needed to construct the portfolio. Pure passive portfolios are managed without placing valuation judgments on the individual assets, economic sectors of the market, or the market as a whole. Studies of manager performance and academic research on the efficient market hypothesis, as well as increased cost consciousness, have led to the acceptance of passive management as a viable alternative to active management.
Historical Median Manager Performance
Historical evaluation of active managers’ performance relative to the market indicates that within some market segments, it has been difficult for active managers to beat the index consistently. Exhibits 1 through 4 show cumulative returns for median active managers relative to a market index that is representative of the returns from passive management. These graphs illustrate the trends of the median active manager’s performance over time. A positively sloped line indicates that the median active manager is