February 21, 2024


The New York Stock Exchange (NYSE) in New York, USA, Tuesday, March 28, 2023.

Victor J. Blue | Bloomberg | Getty Images

As investors navigate another year of uncertainty in the markets, actively managed funds can bring differentiated performance to their portfolios if traders choose carefully.

Actively managed funds have historically underperformed passive strategies, but 2022 is a better year for stock pickers than most.Only a slim majority of large-cap fund managers lagged benchmarks last year, according to data S&P Global’s SPIVA US Scorecard. The company noted that this was the lowest rate of underperformance in the category since 2009.

To be sure, it’s not exactly a resounding endorsement. Investors can easily be charged high fees and capital gains taxes, making many actively managed funds poor substitutes for passively managed strategies that can mimic benchmarks at a lower cost.

Still, actively managed funds are more likely to outperform during periods of volatility. Moreover, they beat passive strategies in some less risky categories, with the exception of U.S. large-cap stocks, according to research by S&P.

An actively managed exchange-traded fund called JPMorgan Advanced Equity ETF (JEPI) The yield was 9.59%, driving investor interest in the ETF. It now has more than $7 billion in inflows this year, according to FactSet.

For Jennifer Bellis, private wealth advisor at US Bank Wealth Management, it depends on what the investor wants to achieve. Actively managed funds can help diversify portfolios, but investors must do their due diligence, she said.

“It’s more about finding the right manager and the right strategy,” Bayliss said.

Here’s how investors should decide whether they should include actively managed funds in their portfolios — and what they should look for when deciding.

Proven track record is key

For investors evaluating active management strategies, the manager’s track record is the primary starting point. A strong track record over the past 3, 5 and 10 years can show you how a fund and its approach has performed in different market cycles – especially as different investment styles gain and fall from favor.

“Everyone can have a great year,” Bayliss said. “So what you do is research the fund, the manager, and look for a track record. Ideally, what you’re looking for is a 10-year historical review.”

Investors can also vet managers and their teams, as well as their tenure at the fund. They can also conduct a scrutiny of the fund’s holdings to assess how those selections compare to the benchmark. Funds that are too close to the index may not produce any differentiated alpha, and may appear like a passive investment.

Furthermore, even successful managers can have a down year, as past performance is not necessarily an indicator of future success.

Find lower fees

Of course, investors must evaluate whether an actively traded fund is right for them.

For newer, less-capitalized investors, passive vehicles can give them the opportunity to build wealth with a much lower barrier to entry—instead of the often higher fees and capital gains taxes, and the research that active managers bring .

Actively managed funds typically charge an expense ratio of 0.5% to 1%, but costs can even climb above 1.5%, According to Investopedia. Meanwhile, passive index funds average about 0.2%. Other expenses that can be attached include 12b-1 expenses, which are marketing expenses.

“These fees are not required,” Bayliss said. “So, you want to make sure you’re reviewing the prospectus to make sure you don’t have those upfront and post fees because there are a lot of funds that don’t have them. There’s no reason to pay them.”

check diversification

Investors must also evaluate where they want to apply active strategies in their portfolios, such as emerging markets or small caps.

“These markets are so broad and there are so many ideas in them, I think active managers who track these markets and look at the fundamentals can exploit some inefficiencies or find interesting ideas,” said Kathy Carey, director of research at Asset Management. at Baird.

Notably, small caps had the lowest rate of underperformance among U.S. stocks last year, according to S&P Global’s scorecard. Only 40% of domestic small-cap active funds underperformed.

Carey also said investors seeking exposure to more specific emerging-market ideas outside of China may have better luck with an aggressive trading strategy, Baird’s Carey said.

Other interesting strategies among actively managed funds include long-short and total return strategies, Bellis said. The long-short strategy is favored by hedge funds that try to bet on bullish stocks while betting on stocks that are likely to fall. Total return strategies focus on generating income for investors.

Baird’s Carey says investors can evaluate where active strategies can add differentiation to their portfolios.

“Again, there’s an opportunity for active managers to try and figure out where the market is going,” Carey said.