Active vs. Passive
The fourth quarter of 2022 saw broadly positive equity-market performance with the S&P 500 returning +7.6%, the Russell 1000 Mid Cap Index at +7.2%, and the Russell 2000 Small Cap Index gaining 6.2%. Strong returns usually present a headwind for active managers, but the fourth quarter proved productive for actively managed funds.
The defining characteristic of last year’s bear market was the collapsing valuations of speculative growth stocks. A mania for themes such as cloud computing and disruptive innovation during 2016-2021 drove those names to fantastical valuations and bestowed market capitalizations of tens- and even hundreds of billions of dollars on such companies, many of which had yet to turn a profit.
Our ongoing research into the relative performance of active vs. passive fund styles reveals that market conditions play a significant role in the active/passive return cycle. Accordingly, we identified a set of metrics that describe the market conditions we believe influence which of the two management styles is more likely to outperform. This note updates our research efforts through December 31, 2021.
The performance derby between actively managed portfolios and passive benchmarks is strongly influenced by market conditions. Active manager success rates are cyclical, but not random, and are driven by slippage created from style, size, and weighting considerations that result from the imperfect slotting of active portfolios into single style boxes. Moreover, this slippage can be defined and measured, and shows a clear correlation with relative return spreads between benchmarks and their opposite boxes.
Our ongoing research into the relative performance of active vs. passive styles reveals that market conditions play a significant role in the active/passive return cycle. We identified a set of metrics that describe the market conditions we believe influence which management style is more likely to outperform. This note updates our data through March 2021.
The passing of investment legend John Bogle has brought forth many well-deserved tributes to his professional accomplishments. He was a tireless champion of passive investing and the founder of The Vanguard Group which, as more than a few investors don’t realize, also manages almost $1 trillion in active funds.
Relative performance of active and passive mutual funds is one of the leading story lines in our industry, with passive’s recent advantage leading some to argue that it will be the dominant style forevermore. We disagree, and believe that the active/passive relationship has been, and always will be, cyclical.