Monthly Commentary

May 2024 - Active vs. Passive Investing

Dear Investors and Friends,

As we navigate the complexities of the financial markets, Mike and I want to share insights from two highly respected studies that shed light on the ongoing debate between active and passive investing strategies: the S&P SPIVA (S&P Indices Versus Active) Scorecard and the Morningstar Active/Passive Barometer. These studies offer valuable perspectives, particularly when we consider our dual approach to managing investments in both equities and fixed income.

The Case for Passive Investing in Equities

  1. Long-Term Performance: Both the SPIVA Scorecard and the Morningstar Active/Passive Barometer reveal a clear trend: most actively managed equity funds underperform their respective benchmarks over the long term. Per the 2023 S&P SPIVA report, 96.83% of all domestic funds underperformed their comparison benchmark over a 20-year period. The pattern holds true across various asset classes and geographies. For those of us aiming for reliable, long-term growth, this underperformance is a critical factor to consider.
  1. The Impact of Fees: One of the key reasons for this underperformance is the higher fees associated with active equity funds. Active management typically involves more frequent trading and higher operational costs, which erode returns. In contrast, passive funds, such as index funds or ETFs, benefit from lower costs, contributing to their superior performance.
  1. Consistency Matters: Another important finding is the lack of consistent outperformance by active equity funds. Even those few funds that do manage to beat their benchmarks in one period often fail to do so in subsequent periods. This inconsistency highlights the difficulty of relying on active management to deliver sustained superior returns.
  1. The Role of Market Conditions: While active funds may show better performance in less efficient markets or during periods of market distress, these conditions are neither frequent nor predictable enough to justify a broad preference for active management. The cost of waiting for such conditions often outweighs the occasional benefit.

The Case for Active Investing in Fixed Income

While passive strategies have clear advantages in equities, the fixed income landscape is different. Both the SPIVA and Morningstar reports indicate that active management in fixed income has a higher probability of outperforming passive management. Here’s why:

  1. Market Inefficiencies: The fixed income market is generally less efficient than the equity market, providing more opportunities for skilled managers to identify and exploit pricing inefficiencies. This is particularly true in areas such as corporate bonds and municipal bonds.
  1. Credit Analysis and Risk Management: Active fixed income managers can add significant value through in-depth credit analysis and proactive risk management. By carefully selecting securities and managing credit exposure, active managers can enhance returns and mitigate risks more effectively than passive strategies.
  1. Interest Rate and Duration Management: Active managers can also navigate changes in interest rates and manage duration to optimize portfolio performance. This flexibility allows active managers to adapt to varying economic conditions and interest rate environments, which can be particularly beneficial in the fixed-income space.
  1. Historical Performance: Historical data from the SPIVA and Morningstar reports support the superior performance of active management in fixed income. The probability of active fixed income managers outperforming their benchmarks is notably higher compared to their equity counterparts.

RCM’s Approach to Equity and Fixed Income Management

Given these insights, when we manage equity portfolios, we predominantly use broad-based low-cost index funds. This approach aligns with our commitment to cost-effective, reliable investment strategies that maximize potential returns while minimizing fees.

In the realm of fixed income, our approach is different. We have a long-term track record of successfully navigating the fixed income markets and materially beating our indices through active management. Our expertise in this area allows us to identify opportunities and manage risks in ways that enhance returns beyond what passive fixed income strategies can achieve.

By employing this balanced approach—defense through active fixed income management and offense through passive equity investing—we position ourselves to achieve the best possible outcomes.

Please don't hesitate to reach out with any questions or comments. Thank you for entrusting RCM with your capital; it's a privilege to serve you.

Warm Regards,

David and Mike

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Roosevelt Capital Management LLC is a registered investment adviser.  Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies.  Investments involve risk and are not guaranteed.  Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein.

Past performance is not indicative of future performance.  Principal value and investment return will fluctuate.  No guarantees or assurances that the target returns will be achieved, or objectives will be met are implied.  Future returns may differ significantly from past returns due to many different factors.  Investments involve risk and the possibility of loss of principal.

While all the values used in this report were obtained from sources believed to be reliable, all calculations that underly numbers shown in this report believed to be accurate, and all assumptions made in this report believed to be reasonable, Roosevelt Capital Management LLC neither represents nor warrants the values, calculations or assumptions and encourages each prospective investor to conduct their own review of the audits, values, calculations and assumptions.