We are experiencing the second longest bull market in U.S. history. Since bottoming out in March 2009, the S&P 500 has risen to all-time highs, fueled by low interest rates and investors chasing higher stock returns.
This historic run has led some to challenge the merits of active investment management. While active investing involves expert portfolio construction, measured allocations of capital to the best investments and being discriminant about security pricing, it can have a tendency to miss out on a portion of the rises. Index investing typically shows better performance results in prolonged bull runs.
But this is just one side of the equation. While active management can lag in long bull markets, the exact opposite can happen in extended market corrections. Actively managed investments typically protect capital better.
To me, the argument about which approach is better is getting long in the tooth. This is not a game or a competition; it’s about meeting our clients’ goals and helping them achieve financial success. For that, I believe we should use all of the tools and expertise at our disposal to make intelligent investment decisions. Combining active and index investing allows us to better navigate the entire market cycle.
What is active investing?
The goal of active investing is to achieve precise return and risk profiles by selecting the appropriate weights of specific investments at the right time. Professional managers of active investments rely on analysis, expertise and experience to build and maintain their portfolios in attempts to own the securities they favour and avoid the ones they don’t to achieve their desired level of return and risk.
What is index investing?
Rather than analyzing individual investments or targeting a specific return and risk profile, index investing replicates the holdings and weights of a broad market index to achieve the aggregate return of all securities in that market. There is no analysis of individual investments. The goal is to replicate highly recognized broad market indexes.
Why it makes sense to combine them
If the market continues to trend upwards, a strategy that includes index investing would potentially do well. During periods of market turbulence, however, a strategy using active investing would potentially better navigate a more volatile period. It’s interesting to note that these typically occur more frequently and with more severity than what we have witnessed recently (hard to think that the global financial crisis happened nearly 10 years ago).
I think we should always be smart about investing. Active and index investments are both effective solutions that allow us as investment managers to make intelligent decisions when creating complete portfolios. We should use active and index investing when it makes sense, allowing us to be forward looking and dynamic.
At the end of the day, MD will focus on achieving our clients’ financial goals and use the best tools for the job at any particular time. Similar to how doctors provide different care and use different tools for different patients, we need to be agile and demonstrate the ability to adapt when necessary.
MD’s proprietary models that blend active and index investments go beyond the argument to understand the unique benefits of both approaches, but more importantly, understand how the combination can create a better client outcome.
As part of our investment process, MD will continue to monitor the validity of both strategies from different points in the market cycle—the active and index investment decision can and will change over time.
We design our investment portfolios to provide returns that grow the wealth of our clients in order to achieve their financial objectives while minimizing risks and the potential for bad outcomes. For this purpose, I believe a blend of active and index investments makes the most sense.
About the Author
CRAIG MADDOCK, CFP, CFA, CIM, MBA, is Vice President with the Investment Management team at MD Financial Management. He leads the team of portfolio managers and investment analysts responsible for managing the firm’s mutual funds and investment pools.More Content by Craig Maddock