Revisiting Active vs. Passive Investing in the Late Stage of the Cycle  |

Written by: CION Investments for

Robo-advisors have seen huge inflows over the past decade, as investing is now as easy as checking a few boxes on an online questionnaire and linking your bank account. Whether you are saving for retirement, want to build towards a down-payment on a home or even just fund a vacation, programs that use an algorithm to invest in index-tracking ETFs have great appeal. And because we have been in a history-making economic expansion – 10 years and counting as of July 2019 – both the stock market and some parts of the bond market have been posting gains year after year.

However, Wall Street consensus has now coalesced around the opinion that the economy has entered the “late stage” of the business cycle – the one right before a recession. This stage typically sees increased volatility and slower growth.

We’re taking a closer look at whether the premise of robo-advisors – that the lower cost of passively tracking the market will outperform active investing over time – will be likely to stand up to a different phase of the business cycle.

We’ll also discuss whether a passive approach to investing, even when overlaid with risk profiling and goal setting, is the best way to think about your financial future.


It’s easy to see why low-cost passive investing has rapidly scaled assets – since 2009, the S&P 500 has posted several yearly outsized returns (over 20%) and an average annualized return of 14.3%. While the bond market has not performed as well (equities and bonds are usually inversely correlated), bond ETFs have also gained momentum as investors used them to fill out asset allocations. But there’s a deeper story to tell. Several atypical events have been major forces in the market, due to government response to the Global Financial Crisis.

Government stimuli targeting industries was significant, including bailouts, business investment programs and tax rebates. Once the recovery was underway, investors re-entered the market, and with stock price levels depressed from 2008 losses, stocks experienced significant lift.

In addition, Federal Reserve policy of slashing rates followed by three rounds of quantitative easing resulted in a healthier economy and increased the attractiveness of risk assets – a classic case of a rising tide lifting all boats, and a perfect scenario for index-tracking investments.

If we take a perspective on the market over multiple decades, a different picture emerges. Over the thirty years ended June 2019, the average annualized return of the S&P 500 is only 7.2%. (see Chart 1). The longer investment horizon incorporates several cycles of economic expansion and contraction, and provides a more realistic way to match market returns to an investor’s timeframe.

Perspective Redefines Performance (Chart 1)

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Source:; S&P 500 average annualized return with dividends reinvested and adjusted for inflation.


With the economic cycle firmly in late stage, economists are projecting slower growth as the effect of government stimulus fades and business investment remains soft, and increased volatility as individual stocks peak and decline. The path of interest rates is increasingly unclear, which weighs on both bonds and equities. In addition, global geopolitics, trade tariff negotiations and the upcoming election in the U.S. can only increase uncertainty.


In this environment, fundamental research at the stock level, and economic research in sector and geographic allocations can add value. However, it‘s important to note the “can”. Not all managers have equal skill. When comparing active management to passive index tracking, it’s common to see all managers in an entire universe compared to an index. We believe this can be misleading.

Information on fund manager performance is widely available, and there are adequate and accessible forms of measurement – everything from in-depth analysis of fund history to simpler statistics like asset size and tenure – that can serve as an assessment of manager skill.

Limiting the universe of active management to those managers that market participants and analysts have already decided possess such skill, either by investing with them consistently or comparing their returns to others in the same peer group and ranking them, can provide a more subtle and meaningful analysis.


In the analysis below, the two principles outlined above are combined: the investment timeframe is longer to provide perspective beyond the current cycle, and the universe of active funds in each asset class is a simple average of the 25 largest by assets under management as of December 2018 with manager(s) tenured 10 years or more. Metrics presented for the Passive Fund are those of a single, investable index fund that tracks the same index against which the active funds in each asset class are benchmarked, e.g., in the US equity asset class, Passive Fund metrics are those of the SPDR S&P 500 ETF [ (SPY)].1 The most important metric is that all returns are presented net of fees.

As can be seen in Chart 2, over a 19-year period, in every asset class active investing outperformed passive. Looking at the data, the incremental outperformance ranges from 0.8% to 3%.

Down to the Details: Every Asset Class Actively Outperforms (Chart 2 )

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Source: 2019 YCharts, Inc. Can Active Management Still Add Alpha

Some investors may feel that the ease of passive investing outweighs the additional return. Looking at returns expressed in average annual return percentages instead of the growth of an investment in dollars over the same time period provides a measure of distance from the impact on an investor. Examining how a hypothetical portfolio would perform in cumulative return expressed in dollars earned by active management vs passive indexing can help investors quantify the gains.

Chart 3 presents the growth of a $10,000 portfolio over the same 19-year period. All asset classes improved the original investment – effectively making the case for long-term investing – but the active managers were able to add significant value, as in the case of Small-Mid Caps (an inefficient market) where manager skill more than quintupled the initial investment.

…But Let’s Talk About The Money (Chart 3)

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Source: 2019 YCharts, Inc. Can Active Management Still Add Alpha

A Snapshot of the Scope of Cumulative Outperformance (Chart 4)

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Source: 2019 YCharts, Inc. Can Active Management Still Add Alpha


The returns analyzed above are just for individual asset classes – which isn’t the way most people invest. Portfolio construction involves selecting amongst asset classes to develop an integrated suite of investments that are matched to your goals and risk tolerance. Passive robo-advisors do this for the initial investment, and then rebalance periodically thereafter, usually annually.

Because they are tracking an index, however, they cannot respond tactically to changes in interest rates, global economic events, company news, or seasonal investing patterns. A landmark study by Ibbotson2 examined mutual funds and pension funds and concluded that an active asset allocation that takes these factors into account added approximately 60% of the incremental return of a portfolio.


We’re not arguing that there is no place for passive investing in portfolio construction – the charts above demonstrate that there are some asset classes where enough information may not be available to active investors to allow them to add value with fundamental research, such as Emerging Markets. Adding an ETF to an actively managed portfolio can solve this problem, and a dynamic asset allocation may help mitigate risk if other factors turn negative. Similarly, while an index-tracking ETF can be a low-cost way to fill part of a fixed income allocation, adding an actively-managed component can potentially enhance income.


As discussed above, we believe there are several quantifiable reasons in support of an actively-managed portfolio, even if you combine passive elements for some of your asset allocation. However, there is an additional element to consider – you.

Your goals and the life events you plan for are certainly more complex than an automated investment strategy derived from a check box list can reflect – not to mention the things life throws you. Engaging with your investing life in a series of small steps and big milestones – and stopping to review and revise plans along the way – is a more comprehensive approach to your financial journey.

You may choose to work with an investment advisor who can tailor a couture plan that offers the potential for greater return and increased diversification through incorporating passive ETFs along with actively-managed structures that access alternative areas of the market. Or you may decide to dive in and do the research yourself, working with an online brokerage to cobble together a portfolio of passive ETFs, active funds, and individual stocks/bonds that you feel reflects your goals. The most important thing is to realize that investing isn’t just a “one and done”.

Taking an active approach to your financial future can get you where you want to go.


  1. The full list of passive fund indices is as follows: U.S. Equity – SPDR ® S&P 500 ETF (SPY); Int’l Equity – Vanguard Total Int’l Stock Index Inv (VGTSX); Fixed Income – Vanguard Total Bond Market Index Inv (VBMFX); U.S. Small-Mid Cap – IShares Russell 2000 Small-Cap Idx Instl (MASKX); Vanguard Emerging Mkts Stock Idx Inv (VEIEX).
  2. 2012 CFA Institute, David Larrabee, CFA Setting the Record Straight on Asset Allocation

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Equities Contributor:

Source: Equities News

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Symbol Name Price Change % Volume
SPY SPDR S&P 500 ETF Trust 309.55 0.45 0.15 52,001,874



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