Active or Passive? Multi-asset Investing Can Turn Both Valves

Investors, whether institutional or individual, face a common challenge: how to get the return they need, at an appropriate risk level, and at a fee they can afford. I touched on this in my very first post.

Along the way, investors often perceive a philosophical fork in the road. In one direction, they see active investing with its goals of insightful decision-making aimed at outperforming the broad capital markets. On another path, they see passive investing with its goals of low-cost diversification within a swath of the market or a market segment.

In fact, the road is not forked. Too often the active/passive debate is viewed as a binary bet between performance and cost savings. But that’s like stepping into your morning shower while adjusting just one of the two water valves protruding from the wall fixture. Turn just one knob, and eventually the experience hurts.

At Russell, we build multi-asset solutions designed to meet investor goals net of costs and in many cases net of taxes. In doing so, we are unabashed believers in paying for the extra return potential from active management when we think it’s worth the cost. But we also can argue that Russell created early versions of “smart beta” indexes 30 years ago. The indexes help us better evaluate markets and investment strategies as well as fulfill specific purposes in our funds and therefore recognize the need to use these options when it makes sense.

Today the active/passive decision is more complex and nuanced, so we are focusing on the development of outcome-driven investment solutions powered by both parts of this equation. The conversation among investors and advisors is now driven by how to intelligently deploy active/passive, rather than whether to pick one or the other.

Think of the marketplace as offering two potential sources of excess return:

• Alpha is generated by active decision-making based on specific insights and analysis of the markets.
• Strategic or so-called “smart” beta is generated by committing to various factors within the markets – factors such as value in stocks, momentum in commodities or credit in fixed income. Since these “smart betas” don’t forever provide superior returns, we recognize that rotating exposures to these strategies can also add value in portfolios.

At the core, we believe in active manager alpha because our research helps us identify talented investment managers. However, active management, just like your favorite darling in the stock market, may move in or out of favor. We also understand some areas of the market may be more fertile than others for active managers – areas like emerging markets and small cap stocks where access to information is more difficult and investor choices are more limited.

Bottom line: The dynamics of balancing exposure to both active decision-making and market factors is, in itself, an active process. Investors must have a way to determine if now is the right time to have more or less active management in various asset classes. Timing is difficult, and we admittedly will not always get this precisely right. However, avoiding the active management cycle peaks and taking advantage of extreme bottoms in markets may help investors ensure that the cost of fees is intelligently spent. This dynamic balancing act is the core of the multi-asset investment process.

In the end, investors can answer the active-or-passive debate with a deliberate grip on both control valves.

Disclosures:

Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional. Investing involves risks, principal loss is possible.

Multi asset investing does not assure a profit or protect against loss.

Russell Investments is the owner of the trademarks, service marks and copyrights related to its indexes.

Russell Investment Group is a Washington, USA corporation, which operates through subsidiaries worldwide, including Russell Investments, and is a subsidiary of The Northwestern Mutual Life Insurance Company.

Copyright © Russell Investments 2014. All rights reserved. This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an “as is” basis without warranty.

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