The basic advantages of passive investing are clear: it typically leads to lower fees, it reduces the chance of serious underperformance and investments are normally quite liquid, said Kurt Umbarger at the 2018 Defined Contribution Investment Forum in September.

Of course, there are potential disadvantages, he acknowledged during his presentation at the event in Toronto. These include that passive investing can lead to concentrated exposures, since even broad market funds can’t help tilting their exposure to bulkier parts of the market, such as technology, he noted.

“The reason the active investing matters, to my mind, is how it affects outcomes,” said Umbarger, global equity portfolio specialist at T. Rowe Price.

Read: Customization, complexity among key trends as ETFs evolve

In making the case for active investing, he noted it’s the only option where the investor has the ability to outperform the market. While it does come with higher fees than passive, the tradeoff is giving up that ability, which should be considered as a cost to the investor, said Umbarger.

Today’s market environment — the height of a long bull run — is an example of where passive investments are at their best, he said, noting richer valuations lead money managers to behave more cautiously, which dampens the potential gains of going active.

All markets, he reminded the audience, are cyclical, so the current landscape should eventually see a downturn, which is where active managers tend to do their best. If everything is going well, said Umbarger, it’s easy for passive to demonstrate a meaningful advantage.

Read: Pension plans navigating a world of ‘stable instability’

“We see these crescendos where you roll over from a a big bull market into a bear market, active management has actually done better,” he said.

An example of this playing out was the tech bubble of the late 1990s. Leading up to it, markets were soaring and active managers were doing poorly, leading some to question active management. However, when the bubble burst, active managers were much better equipped to cope with the rapid downturn, noted Umbarger.

“I don’t think the next 10 years are going to provide the same type of returns to your members as the last 10 years,” he said.

The majority of active managers, although not all, actually do better than their benchmarks on a consistent basis, he added. However, the last 20 years have seen an explosion of managers and products hitting the market, said Umbarger, which means there’s limited alpha for investors to take advantage of and some managers will fail. He suggested the investment world is currently in a period of consolidation because there just isn’t enough room for everyone to take part in the limited alpha the market has to offer.

Read more stories from the DC Investment Forum

Copyright © 2019 Transcontinental Media G.P. Originally published on benefitscanada.com

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