Pirri says his firm uses active managers when it comes to investing outside of the typical U.S. large cap equity sectors. In international investing, he chooses active managers who have the ability to buy stocks or bonds that aren’t included in an index. But he’s also selective, looking at active managers with long track records of outperformance. The same goes for small cap active managers, he says.
Fixed income is another popular asset class in which to opt for active strategies. Painter and Pirri say active management in fixed income is superior, since it can much more easily outperform the benchmark Bloomberg Barclays U.S. Aggregate Bond Index.
For Painter, again, it comes down to customization for retired clients. He says he can stagger maturities for a client who needs a certain amount of income in the next few years versus a client who needs consistent income, allowing him to arrange maturities differently.
Ashfield’s Johnson says active strategies let him take advantage of market dislocations or overreaction to near-term trends in a way passive ETFs can’t. He says the amount of money that’s going into passive investing is actually “creating some opportunities for arbitrage.”
Johnson used retail stocks as an example, noting there’ve been significant valuation divergences between pure online retail operations with no physical presence and brick and mortar retailers that are trying to pivot to online shopping to augment their physical stores.
“There’ve been opportunities to own shares in businesses that are going to perform well in the long term, but in the near term, they’re undervalued, in our estimation,” Johnson said.
Health care is another area where he thinks stock picking is superior. Ashfield is overweight health care stocks versus the benchmarks, but the firm is focused on companies specializing in cost containment, information technology and medical devices. The only time Ashfield uses an ETF for its health care holdings is when using an equal-weight biotechnology ETF, at a 3% weight.
“It’s a good example of where an ETF can be complementary to a core [stock-picking] strategy, because biotechnology is a subsector that’s relatively young, has high growth, but high risk and a lot of failure,” Johnson noted.
Risk Management Advantage
The financial advisors had different views on how well active management does in giving outperformance or ensuring risk management. Painter says active management strategies for his retirees are to provide steady income and maybe a little upside during rising markets. If he uses ETFs, it’s as a risk management tool, an overlay to the active management.
“If I’ve set income goals and need to have stocks to reach those income goals, and things are difficult like they currently are, I can—depending on the situation—buy put options or short the S&P 500 to reduce my overall market risk,” Painter explained.
Pirri thinks active management can reduce drawdown during volatile swings, noting that an active manager has the ability to get more defensive, whereas a passive index can’t change direction. “If you’re sitting in a passive index in a drawdown period, you’re going to get killed,” he said.
Market conditions may also make active preferable to passive, Pirri says, noting that from 1999 to 2009, passive index returns on the S&P 500 were lackluster, whereas in the bull market of the past 10 years, passive has performed well. Times might be changing again.
“In periods of more volatility and when the market gets long in the tooth like now, that’s when you see active management really take over,” he said.