Editor: Nadeem Mian
The recent bull market which began in March 2009 was the longest on record lasting 131 months. From trough to peak the S&P 500 had a return of over 350% trailing only the bull market of the 1990’s which yielded 417%.
Despite its magnitude, this time period was often termed as “the most hated bull market” due to the lingering memory of the financial credit crisis. However, one of its biggest beneficiaries has been passive investing and Electronically Traded Funds (ETFs). As of September 2019, passive equity funds overtook active equity funds in terms of assets under management. In an up-trending market where everything was rising with the tide, buying a low-cost ETF (or Index Fund) benchmarked to -for example the S&P 500 was almost a no brainer.
Why pay extra fees for an active fund manager or a financial advisor? The answer to that may be the market meltdown of 2020.
In today’s extremely volatile markets, fees suddenly taken a back seat. Who cares if you’re saving 50 basis points (bps) a year when the Dow Jones Industrial Average just dropped by 1000 points in a day? Investors are looking for answers that passive managers are not designed to answer.
To get a better understanding of the difference between the two – we need to understand the goals of their respective strategies. A passive investor/fund attempts to match the performance of a given index by owning all the stocks in that index in the same proportion usually through an ETF. Active investing on the other hand, involves the goal of beating the benchmark usually with a portfolio managers who will use their assessments to choose attractive investments.
With this difference in mind, here are three benefits for active investing during the COVID-19 Era:
- Risk Management: Active managers can modify investors’ portfolios to align with current market conditions/views. For example, in 2007 as cracks in the financial credit markets were being exposed, active managers would have been able to reduce or eliminate their holdings in financial stocks, cushioning the downside. There are also plenty of examples where we see market indexes become overweight in one sector and/or specific holdings which for a passive investor can result in a higher risk exposure. Active investors on the other hand can adjust those allocations to reduce risk levels.
- Opportunistic: Market efficiency has been the claim to fame for ETFs – why bother trying to beat the market when the market is already perfectly priced? While it’s hard to beat that debate during stable markets, extremely volatile markets create inefficiencies. For example, when the tech bubble popped in March 2000, it took the NASDAQ about 15 years to get back to that level. However, individual stocks like Apple, Amazon, Priceline, etc. broke their peak 2000 levels years in advance, making the case for stock picking. Even during a period where the broad market is going sideways, active investors can benefit. In any given year if the S&P 500 had a return of 0%, an active money manager may still be able to post a positive return by overweighting sectors and stocks that yielded a positive return.
- Personalized to Meet Goals: Every investor has a different set of circumstances with different needs and goals. Whether it’s cash flow needs, taxes or retirement planning, an active approach with the help of an investment professional may be the best option to build a customized solution. Specifically in the Sharia-compliant world of investing – although we have seen progress in passive low cost investment solutions – a more comprehensive portfolio may be more suitable for some investors, especially those who are accredited.
We’re certainly not calling the end of passive investing – as even the great stock picker Peter Lynch would admit, that it is here to stay – but a present and post COVID-19 environment may give active managers an opportunity to get back on the field after being benched these past few years.
If history can serve as a guide, what we’ve learned from previous aftermaths of a market crashes is that:
i) The market may still be in a period of choppiness for some time before things get better
ii) Even when that choppiness ends, some sectors will take longer to come back than others, and
iii) Some stocks may never come back.
Ultimately, we believe a portfolio that has a combination of the two approaches may be the best way to go. For example, the core-satellite strategy, which we recommend to ShariaPortfolio clients, includes a passive component (with benefits of having broad market/asset exposure at a low cost) as well as an active piece (with the goal of enhancing return, reducing risk and/or catering to a specific client objective). For more information, please contact one of our Financial Advisors.
Investing in securities involves risk, and there is always the potential of losing money when you invest in securities.
Halal compliant investments, diversification and asset allocation do not ensure a profit or protect against loss.
This material is intended for informational purposes only and should not be construed as legal or tax advice, nor is it intended to replace the advice of a qualified attorney or tax advisor.