Advisors Find Success Combining Active and Passive Investing

You could say that Phoenix-based advisor Alexander G. Koury likes to blur the line between active and passive investing.

Like many advisors, especially registered investment advisors (RIA), Koury uses passive exchange-traded funds.

“I use them to keep a portion of the portfolio passively invested as part of the long-term strategy,” he said Koury, an advisor with Householder Group Estate and Retirement Specialists.

With regulation, low interest rates and other pressures affecting the investment world, advisors need to marry active and passive to do right by their clients. Many are finding creative ways to get the best from both worlds.

If the market rises, Koury's ETF fund assets rise along with it and if the market goes down, those assets fall. But Koury also uses ETFs for tactical or short-term trading, in effect using the passive vehicles in a more active way.

“Part of a client's portfolio I will manage from a market timing perspective to get in and out of positions quickly,” Koury said. “You can use ETFs as part of an active management strategy, but you must be sure what you are buying and what you are selling.”

Howard Erman uses passive investment vehicles as a complement actively managed funds from American Funds, John Hancock and JP Morgan.

Staying passive isn’t enough, said Erman, a financial planning and tax advisory that bears his name.

“If I just buy ETFs and they follow along with the market, then you aren't really adding anything,” said Erman, in Seal Beach, Calif.

“My thinking is that we need to seek better returns, give the client a better chance at a successful retirement and an active manager can be an asset in this goal, managing and trading these funds,” Erman told InsuranceNewsNet last year.

He compares active management to driving a car around potholes or taking stock of street signs.

“I want an active manager there who can navigate through all that stuff,” he said. “An active manager is a partner, who makes the day to day research and trading decisions.”

Advisors Use Both Strategies

Mixing active and passive strategies is no accident, said consultant Howard Schneider, author of a report out this month on passive and active strategies used by advisors.

Advisors prefer active strategies for equity fund categories such as emerging markets, specialized equities, international equity and mid- or small-cap equities, Schneider said.

But when it comes to large-cap funds, advisors prefer passive approaches, he said.

On the fixed-income side, in the rising interest rate environment of the past 10 months, advisors have shown a preference for active strategies to manage “less efficient” asset classes: international global fixed income, strategic and high-yield fixed income.

With inflation-protected funds and U.S. government bond funds, asset classes where fund managers have less of an impact on the performance of the assets, advisors prefer to remain passive, Schneider explained.

With U.S. market indices hitting records, a fiduciary standard percolating through the retail advisory world and assets pouring into passive investments, advisors need to explain how active investment strategies work with passive approaches, said Schneider.

Clients aren’t asking advisors to use one strategy at the exclusion of the other, so advisors don’t have to feel as if they are on the defensive, he said.

Instead, advisors want to be able to explain – defend, even – their active approaches and clarify how an active-passive, two-step approach shields investors against risk and market volatility to offer clients the buffer against market troughs.

Some active management adherents have already integrated that approach into their value proposition to explain how they manage money. “They tell clients so clients are buying into that philosophy,” Schneider said.

Advisors can expect clients to ask more questions about the success of passive investing as billions of dollars surge into index funds and ETFs.

The False Divide

From 2007 through 2016, index domestic equity mutual funds and ETFs received $1.4 trillion in net new cash, according to mutual fund tracker Investment Company Institute.

By contrast, actively managed domestic equity mutual funds experienced a net outflow of $1.1 trillion over the same period.

But with $16 trillion in assets managed by mutual funds in the U.S. at the end of 2016, active investing hasn’t disappeared.

The bipolar world of active vs. passive is false divide, Schneider said.

The more interesting narrative lies with the tidal shift between active and passive investment where market environments or asset classes favor one approach over another, and how advisors blend both approaches is where the active-passive story lies.

“It really isn’t about which one is winning and which one is losing, it’s really about how do I use these two together,” Schneider said.

InsuranceNewsNet Senior Writer Cyril Tuohy has covered the financial services industry for more than 15 years. Cyril may be reached at [email protected].

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