Active vs.

Passive: The Basics

Active management is simply an attempt to "beat" the market as measured by a particular benchmark or
index. The aim of active fund management after fees are paid is to outperform the index for a
particular fund (not to mention other fund managers they may be competing against).
Passive management is more commonly called indexing. Indexing is an investment management approach
based on investing in exactly the same securities, in the same proportions, as an index. The management
style is considered passive because portfolio managers don't make decisions about which securities to buy
and sell; they simply copy the index by purchasing the same securities included in a particular stock or bond
market index.
Which Approach Works Best?
That's a never-ending debate. Hard facts aside, active and passive management are in many ways similar to
political parties. The two camps see the investment world in very different ways, both making logical and
passionate arguments for their viewpoint.
Indexers generally believe that it is difficult to beat the market. Therefore, they essentially offer asset class
performance that closely matches an index for those investors who are unwilling to assume the risks of
active management.
Active managers believe the market can be beaten. While they can't beat it all the time, many active
managers do believe there are certain irregularities in the market that can be taken into consideration to
achieve potentially higher returns.

The Active Approach:

Active Management Advantages

Expert analysis Seasoned money

managers make informed decisions based
on experience, judgment, and prevailing
market trends.
Possibility of higher-than-index returns
Managers aim to beat the performance of
the index.
Defensive measures Managers can make
changes if they believe the market may
take a downturn.

Active Management Disadvantages

Higher fees and operating expenses.

Mistakes may happen There is always the

risk that managers may make unwise
choices on behalf of investors, which could
reduce returns.

Style issues may interfere with performance

At any given time, a manager's style may
be in or out of favor with the market, which
could reduce returns.

The Passive Approach:

Passive Management Advantages

Passive Management Disadvantages

Low operating expenses.

No action required There is no decisionmaking required by the manager or the

investor.

Performance dictated by index Investors

must be satisfied with market returns
because that is the best any index fund can
do.

Lack of control Managers cannot take

action. Index fund managers are usually
prohibited from using defensive measures,
such as moving out of stocks, if the
manager thinks stock prices are going to
decline.

Taking a Long-Term View

The investment community will continue to debate the benefits of active versus passive investment
management. And from time to time, one approach will be more popular than the other. Within the equities
arena, in particular, the passive managers have done well over the last decade but the trends maybe
changing as the secular bull market of the late 20th century is over. During challenging sideways markets
the active manager at least has an opportunity to take action, which puts the passive manager at a distinct
disadvantage. Take for example the secular bear market of 1966 - 1982, which generated a negative
(1.18%) compounded annual rate of return over 16.5 years. That's a long time of sub par performance that
the passive managers conveniently hide when they preach about their long-term trading performance.
Within the alternative investment arena the differences between passive and active managers are even
more pronounced. The bullish bias of equities are not typically seen on the cyclical nature of commodities.
Certainly over short periods passive managers can do well, especially if their portfolios are heavily weighted
in explosive markets. But for the most part and over a longer time period the active manager should out
perform the passive managers for the simple reason they can react to changing environments while passive
managers are really only there for the ride.