Performance
The effectiveness of an actively-managed investment portfolio obviously depends on the skill of the manager and research staff but also on how the term active is defined. Many mutual funds purported to be actively managed stay fully invested regardless of market conditions, with only minor allocation adjustments over time. Other managers will retreat fully to cash, or use hedging strategies during prolonged market declines. These two groups of active managers will often have very different performance characteristics.
Approximately 20% of all mutual funds are pure index funds. The balance are actively managed in some respect. In reality, a large percentage of actively managed mutual funds rarely outperform their index counterparts over an extended period of time because 45% of all mutual funds are "closet indexers" funds whose portfolios look like indexes and whose performance is very closely correlated to an index (See the term R2 or R-squared to determine correlations) but call themselves active to justify higher management fees. Prospectuses of closet indexers will often include language such as "80% of holdings will be large cap growth stocks within the S&P 500" causing the majority of their performance to be directly dependent upon the performance of the growth stock index they are benchmarking, less the larger fees.
The Standard & Poor's Index Versus Active (SPIVA) quarterly scorecards demonstrate that only a minority of actively managed mutual funds have gains better than the Standard & Poor's (S&P) index benchmark. As the time period for comparison increases, the percentage of actively-managed funds whose gains exceed the S&P benchmark declines further. This may be due to the preponderance of closet-index funds in the study.
Only about 30% of mutual funds are active enough that the manager has the latitude to move completely out of an asset class in decline, which is what many investors expect from active management. Of these 30% of funds there are outperformers and underperformers, but this group that outperforms is also the same group that outperforms passively managed portfoloios over long periods of time.
Due to mutual fund fees and/or expenses, it is possible that an active or passively managed mutual fund could underperform compared to the benchmark index, even though the securities that comprise the mutual fund are outperforming the benchmark, because indexes themselves have no expenses whatsoever. However, since many investors are not satisfied with a benchmark return a demand for actively-managed continues to exist. In addition, many investors find active management an attractive investment strategy in volatile or declining markets or when investing in market segments that are less likely to be profitable when considered as whole. These kinds of sectors might include a sector such as small cap stocks.
Read more about this topic: Active Management
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—Ralph Waldo Emerson (1803–1882)
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