Active vs. Passive Investing


It seems like all we hear about today from the Wall Street Journal, Bloomberg, and other market media outlets is the attack on active management and the support for passive management (indexing). This conversation really took off last year when the S&P 500, Russell 2000, and other major indices hit record highs while in some cases active management just did not keep up. That trend has continued over the better part of this year, despite the recent volatility we have experienced over the last month. So the question “Why shouldn’t I use index funds?” has become a question on every investor’s mind.

While there is no simple solution to this question I can help illustrate some key points surrounding the Passive vs. Active debate.

  1. The key characteristic of passive management is, for a minimal fee, your money is being put to work in an index fund that captures every company in that given index (ie. S&P 500). This results in a portfolio made up of 500 names (in the case of an S&P 500 index fund) weighted based on their individual market capitalizations. While this is an inexpensive way to participate in market gains, it is important to remember that index funds also participate fully in a market down period; which is seen by many investment professionals as a cause for concern in the passive investment strategy.
  2. Active management means that your money is being put to work by investment professionals who utilize hands on research when selecting the appropriate stocks to buy and sell. This typically results in a portfolio made up of a smaller number of holdings containing quality companies that these professional investors and researchers think will have success in the future.

Here at Legacy Trust, we believe in the active management approach to investing. We have investment professionals on staff and also partner with a third party research team that spends countless hours researching managers and holdings that fit our investment strategy, while also fitting the client’s specific financial plan. We look for managers with a strong performance track record and characteristics that will provide the best results to a portfolio while protecting in a market downturn. One key statistic we evaluate when researching managers is the up/down capture percentage. This statistic shows how the manager does when the overall market is up and also how the manager performs when the overall market is going down. This may be the single most important factor for our clients; they want to participate in an up-market but want to minimize losses as much as possible in a down-market. By avoiding many of the low quality companies that often are included in a typical index fund; we can deliver superior risk-adjusted returns over the long term.