Kevin E. Donovan, CFA
Kevin E. Donovan, CFAPortfolio Research Director

There has been a lot of talk over the past few years about whether or not active mutual fund portfolio managers really add value compared with passive investment strategies represented by exchange-traded funds (ETFs) tied to an index.

The argument for passive stock ETFs, by the firms that sell them, has been compelling:  stock indexes such as the S&P 500 have outperformed the average actively managed mutual fund over the past several years.  The basic argument is that markets are efficient, pricing in news instantaneously so that no investor can hope to outsmart the market.  Thus investing in a cheap index fund is the most cost-effective and most successful way to gain exposure to stocks.

Naturally, companies that sell actively-managed funds dispute this.  They note that the comparison ETFs use is with the “average” fund, without distinction as to what the strategy of that mutual fund may be.  A study by Fidelity Investments purports that the lowest expense funds from the five largest mutual fund companies consistently beat ETFs over time.

Years of reading these studies have shown us that you can make any investment look superior if you pick the right time period for your comparison.  Investing styles go in and out of fashion as time goes by.  Value stocks may outperform over certain periods of time (as in 2016) while growth stocks outperform at others (this year so far).  Depending on what start and end date you pick you can make a compelling case to go all in on value or to load up on growth.  Looking over the long term, or better yet, balancing your portfolio between value and growth is the way to ensure you aren’t caught on the wrong side of the fence when fortunes quickly change.

We believe the same is true of active and passive funds.  It is true that when the S&P 500 is leading the world’s stock indexes higher than a passive fund is hard to beat.  It is also true that when markets plunge and investment in a passive index fund will be exposed to the full losses suffered by the market.

We pay attention to how the actively managed funds we use perform during periods when markets fall.  In the long term, avoiding steep losses is just as valuable to achieving your investment goals as is participating in bull markets.  An investment that loses less has a much easier time making up it’s lost ground once the markets eventually begin to rise again.

We tested different portfolios containing the funds we use against an all-ETF portfolio with the same weights applied to each asset class represented over 1, 3, 5 and 10-year periods.  For both a conservative investor with a 50% stock/50% bond portfolio and an aggressive investor with an 80/20 portfolio, the portfolio containing our actively managed funds outperformed the ETF portfolio in most time periods as shown in the tables below:

1-Year 3-Year 5-Year 10-Year
CJM 50-50 Model 10.45% 6.26% 8.29% 6.60%
ETF Only Model 9.21% 5.57% 7.44% 5.75%


1-Year 3-Year 5-Year 10-Year
CJM 80-20 Model 13.21% 7.77% 10.70% 7.24%
ETF Only Model 13.95% 7.43% 9.80% 6.46%

The ETF only model only outperformed for the one year period in the aggressive 80/20 model, while the actively-managed portfolios outperformed in all other time periods and also on a risk-adjusted basis (not shown) because of the active management of volatility and downside market risk.

It’s important to note that even 10 years of data is not enough to decide one way or the other.  Thirty years or more would give us a better idea, but ETFs have been around for a comparatively brief period which makes any certain statement one way or the other extremely premature.

Active and passive funds have their place in our portfolios and we use both to provide cost-effective exposure to a variety of asset classes in order to participate in market gains while keeping volatility in check and guarding against severe losses.