Case for active management gets stronger every day as stocks power ahead

Advisers wondering how long the indexed-investing run can last begin thinking of risk management

Dec 30, 2014 @ 1:34 pm

By Jeff Benjamin

Past performance notwithstanding, investors are expected to emphasize active portfolio management over passive indexed investing in the year ahead.

“The more conservative you are, and lower risk tolerances puts you in active management,” said Tim Holsworth, president of AHP Financial Services Inc.

“We know that active management only beats the market if you bring in the down years, but we're finding that more clients are better suited for active management because of the risk-tolerance issues,” said Mr. Holsworth. “You need to control portfolio volatility because clients start calling the first time they see a 7% correction.”

With the U.S. stock market closing in on its sixth consecutive annual gain, and having gone more than three years without a correction of at least 10%, more financial advisers and market analysts are favoring active management over broad-market indexes that have no ability to navigate risk.

“Good active managers have the ability to manage risk,” said Dan Jacoby, chief investment officer at Stratos Wealth Partners.

USING CASH

Even though Mr. Jacoby expects the first part of 2015 will continue to favor broad market or passive indexed investing, he is positioning his clients with active managers who can use cash to their advantage.

“In an essentially straight up market, cash will be a drag on performance, if you're holding 5% or 10%,” he added. “But in periods of increased volatility or even a sideways market, good managers will be able to take advantage with cash.”

According to the InvestmentNews Outlook 2015 survey of 380 advisers, 73% believe that active management will outperform passive management in the year ahead.

For a lot of financial advisers, the charging equity markets since the low point of March 2009 might have been a relatively smooth ride on just about any broad market index.

But the reality is that every year and every new benchmark milestone surpassed stacks up the risk factors for a pullback, which is a scenario that usually favors active management.

“What indexing will do on the way up, it will also be doing on the way down,” said Noah Hamman, chief executive of AdvisorShares. “As I see it, when you're looking at active management you're not looking at an asset class, you're looking at manager skill.”

Over the long term, Mr. Hamman believes in dollar-cost-averaging a small percentage of a portfolio into a passive index that will ride the market's highs and lows. But he said most investors aren't ready to accept the fact that index funds have no ability to slow down or avoid trouble spots.

“Not every client wants to step on the gas in their portfolio all the time,” he added. “And if you're invested in the S&P, that strategy is never going to turn.”

MORE TIME AND EFFORT

With that in mind, financial advisers who have relied heavily on the six-year market beta play will need to start boning up on active managers, which can involve a lot more time and effort.

“Between the numbers being on the side of passive management and the ease of accessing passive management, it can be a hassle dealing with active management,” said John Rekenthaler, vice president of research at Morningstar Inc.

“You can't get active management very often in an ETF, and you need to be able to track portfolio managers and be ready for surprises,” he added. “But the idea is there will be benefits of investing with active managers as we get along in the market cycle and the possibility of downturn seems stronger.”

Of course, not all advisers are ready to jump off the indexing train just yet.

Theodore Feight, owner of Creative Financial Design, plans to stick with his tactical strategy of using index ETFs to navigate market conditions.

“If I find a good active manager I would tend to stay with him, but I haven't seen any that are good very consistently,” he said. “I'm going with indexes and I adjust them based on what's going on in the cycle, and right now I'm telling people to just grab on and hang on for the next six months, because I think the market is going to be on a tear.”

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