One of the big problems today is that many investors have turned completely to indexing or passive investing. There is nothing wrong with buying a vehicle like the SPDR S&P 500 AND F Confidence (TO SPY) Where iShares Russell 3000 AND F (IWV). They can form large grassroots farms.
But they’re not perfect either. With indexing, you get both the good and the bad. Investors are subject to the general vagaries of the market, and this includes volatility shocks and shocks. Because of the way most indices are weighted by market capitalization, a few stocks can significantly influence their direction and price movements.
But active management can work differently.
On the one hand, active managers do not have to buy all the stocks in an index or in the same weightings as their benchmark. It can help reduce volatility. Second, active managers can focus more on dividends. Dividends have long been a great way to reduce overall portfolio volatility. After all, getting 2-4% in cash goes a long way in increasing yields.
One of the advantages of active management over passive management is probably the possibility of not being 100% invested at all times. Active managers have the flexibility to sell stocks as they see fit and flee to cash if they feel volatility is too high or valuations are too high. However, this is not the case with passive indexing. An index fund will hold all of its benchmark holdings even if stocks rebound or trade with triple-digit P / E’s. This ability to hold cash can be a great way for active managers to reduce losses and improve returns for their shareholders.
A recent NAAIM One study highlights this factor and calls it the “buy and hold equalizer”. Looking at 70 years of market data, active managers can actually be on the wrong side of the market almost 40% of the time and still equal buy and hold returns. Indeed, the ability to flee towards liquidity creates a leverage effect during bull markets. Conversely, the remaining 60% who succeed end up outperforming during times of high volatility.