Inside The Active Vs. Passive Battle

In the endless active versus passive debate, declaring a winner can be complicated.

Managing Editor
Reviewed by: Olly Ludwig
Edited by: Olly Ludwig

In the endless active versus passive debate, declaring a winner can be complicated.

Twice a year, S&P publishes its SPIVA report, and twice a year we get to see what’s better: active or passive management. That seems to be easier said than done.

It turns out different folks see it differently. It also turns out that everybody’s right.

To begin, my colleague Cinthia Murphy played it one way here on, observing that in 2013, the Standard & Poor’s Index Versus Active report showed that active managers focused on midcap stocks and on long-dated gooverment bonds beat their indexes.

There was nothing wrong with Cinthia’s take on the report. Investors shrewd enough—or lucky enough—to tilt their portfolios to those two pockets of the investment universe squeezed out some outsized returns last year.

At the same time, a lot of the coverage of the SPIVA data, such as Sam Ro’s at Business Insider, emphasized something quite different.

He noted, rightly, that most active managers failed to beat their indexes last year and, worse yet, their track records got worse over the three- and five-year periods analyzed in the SPIVA data series.

He’s absolutely right, and so was Cinthia. So, what is the truth?

And The Winner Is …

Folks who know know that we tend to follow what the academic research on the fund industry says.

And what the research says is that, on average, in any given year, about two-thirds of all active managers are outperformed by the indexes they are benchmarking against.

Over time, active management fares even worse, which is what Sam Ro observed.

Sundry studies, repeatable over the decades, lead ardent passive investors like Larry Swedroe to argue that when active managers do indeed outperform, a bit of luck is involved.

It’s not always luck, of course, and that’s why Cinthia and played the SPIVA report the way we did. After all, not all active managers are created equal.

It’s cliché to mention him, but Warren Buffett is the ultimate example that should give all indexers pause, that they shouldn’t allow their passive stripes to morph into some ideology about the futility of even pursuing alpha.

Folks like Swedroe pretty much argue that alpha is so elusive as to be a waste of time and certainly money, but even he remains opens to the possibility that active managers can outperform.


Elusive Alpha

Thus, folks who know us at know that we too remain entirely open to the irrefutable reality that active management can definitely be superior to passive management, even if outperformance is exceptional and difficult to sustain.

Moreover, financial markets need stock pickers and sundry active speculators for price discovery. Without them, markets simply wouldn’t work.

So, at, we recognize outperformance, at the very least, for what it might be; namely, a bit of insight that leads to better returns.

And let’s face it: Such outperformance has a human face.

In the case of midcap stocks, advisors like James Breech, an ETF Strategist at Toronto-based Cougar Global Investors, rightly reckoned U.S. midcap stocks were likely to outperform large-cap U.S. stocks last year.

So what do these different interpretations of the SPIVA data series mean? It depends.

On the one hand, some pure passive investors like Allan Roth will always use index funds for entire portfolios.

That said, some investors will always be looking to generate alpha, and a whole new wave of investors are integrating passive as well as active approaches.

In such strategies, the core of a portfolio is likely to be composed of cheap index funds canvassing broad asset classes.

But at the same time, those same investors—increasingly ETF strategists who favor top-down approaches using ETFs—will tilt portfolios to pockets of the investment universe they consider to be unusually prospective.

And we celebrate that, even if the numbers tell us that, most of the time, such active bets are likely to be wide of the mark.


Olly Ludwig is the former managing editor of Previously, he was a financial advisor at Morgan Stanley Smith Barney and an editor at Bloomberg News. Before that, Ludwig was a journalist at the Reuters News Agency in New York.