Active management: Going beyond the index

04.29.19

Actively managed funds? Passively managed index-based funds? Reports about the merits of each approach are published on a regular basis. Yet the evolving needs of investors mean many financial advisors want the flexibility to use both types of funds in the investment planning process.

Many passively managed funds seek to match the return of a market index, essentially tracking an average. Active managers, however, seek to exceed the returns of index averages by managing securities selections and seeking opportunities using research techniques that go beyond tracking an index. Active and passive investing strategies are not mutually exclusive and many investors use both as they allocate across a balanced portfolio. While Ivy offers passively managed funds, we also believe investors can derive the most long-term benefit through exposure to well-researched actively managed funds.

Why? In our experience, investors don’t set “average” goals – they instead put a priority on important milestones in their lives. When it comes to investing for those major goals, the right information can make a meaningful difference in going beyond average results.

In this review, we take a closer look at Ivy’s commitment to active management and the reasons we believe it can provide benefits to investors. With decades of experience in actively managing money for investors, we’ve learned that differentiated ideas, skilled interpretation of data and experienced professionals are important to successful investing over time.

Our portfolio managers and analysts conduct their own original research, every day. They don’t simply repackage the work of others. This approach leads to individual ideas, collaboration and conviction in the holdings we select. Active investment options typically have higher expenses than passive, but there is more at stake for investors than simply the cost.

Active selection of fund holdings

Because we do our own research, our funds tend to be more concentrated. For example, our equity funds average 55 holdings in each portfolio.1 In addition, 72% of Ivy Funds’ active portfolios have lower turnover than their Morningstar peer group averages.1 We believe it is best to know and understand what you own.

Breakdown of S&P 500 index holdings
Chart Showing Breakdown of S&P 500 index holdings

Top holdings shown as average percentage of total index as of 12/31/2018

Consider funds based on the S&P 500 Index and the several hundred stocks it represents. That many holdings can make it difficult to understand exactly where investment dollars are going and how they are performing. By Dec. 31, 2018, the top 50 holdings within the S&P 500 Index on average made up about 51% of the weight of the index. The top 200 holdings — or 40% — made up about 83% of the index.1

However measured, that concentration indicates that index investors are not getting market exposure that is as wide as the index name suggests. In addition, holdings outside of these concentrated groups may hurt performance in down markets more than they help in up markets. Research shows that since the Great Depression, the correlation of returns was greater in down months than in up months — in other words, stocks tended to move down together. And even in up markets, index investors lose the chance to achieve more than average returns. That may be because of large investors taking short positions in exchange-traded funds (ETFs) and other pooled vehicles to get defensive when the market falls.

From 2008 through 2018, the correlations increased, especially in down months.2 Indexes that track the market overall reflect those close correlations, while actively managed funds have the opportunity to be more selective.

Active management offers potential in rising and falling markets

The “efficient markets theory” states that the prices of stocks and other securities fully reflect all available information at any time. According to the theory, investors find it very difficult to identify securities that allow them to consistently perform better than the market.4

But history shows that markets often are not efficient. Certain categories of mutual funds historically have presented particular opportunities for active managers to outperform. In general, these categories often are considered less efficient in terms of the information available about the types of securities they represent.

In addition, investor behavior can exert a direct impact on prices and markets. Stock market volatility in reaction to geopolitical uncertainty or other factors often has lasted a relatively short time and shown the potential of careful stock selection.

Active managers have the ability to exploit potential market inefficiencies, or to “overweight” or “underweight” fund holdings in different proportions to a given index. Based on that capability, we believe actively managed funds offer the potential for above-market returns as well as the potential for downside protection. That’s a combination the index-tracking funds may have difficulty matching.

Many investors have shown they agree. Of the roughly 11,200 mutual funds and ETFs available at the end of December 2018, approximately 8,700 were actively managed and represented $13.2 trillion of the total $19.7 trillion in assets under management.3

Chart Showing Actively managed mutual funds stats

As of 12/31/2018. 3

We live in a time of global rebalancing, with rapid economic growth in emerging markets as well as accelerating innovation in technology, health care and other areas. These changes often bring opportunity for the right companies and potentially for investors. The Ivy investment team uses a disciplined, collaborative research process as part of our active approach to finding potential opportunities for investors.

1Source: Morningstar Direct as of 01/23/2019

2Sources: Empirical Research Partners, S&P 500 Monthly Average Return Correlations, Small- and Large-Cap Growth Stocks, 1928-2016 ; Morningstar Direct, 1928-2018

3Source: Strategic Insight Simfund, mutual funds and exchange traded funds, as of 12/31/2018

4Source: University of Chicago Booth School of Business, www.chicagobooth.edu


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Past performance is not a guarantee of future results. Investment return and principal value will fluctuate, and it is possible to lose money by investing. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets.

The opinions expressed are those of Ivy Investment Management Company and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon.