Active vs. Passive

Active vs. Passive

Active vs. Passive

Active vs. Passive


The Active vs. Passive Debate

There have been many whitepapers and articles written over the last few years detailing the underperformance of active managers and the rise of passive investing. One of the questions we frequently receive from clients and potential clients in our Large Cap Value Equity strategy is whether there is still a place for active management in large cap. At Great Lakes Advisors, we believe that there is a strong case to be made for our fundamental approach to active equity investing.

Historical data shows us that active and passive strategies are cyclical in their outperformance. The chart below depicts in blue the performance of the Russell 1000 index (passive) and in red the outperformance of active managers. Since the end of 2009, the median of active managers has mostly underperformed the Russell 1000. However, in prior periods, active managers provided excess returns twice as often as they under-performed. This is particularly notable when the market declined, shown below in the white sections when the red line peaks. Limiting losses in a down market can be a key benefit of active management.

For the 21-year period assessed below, an investor who put $1 in a passive strategy following the Russell 1000 index would end up with $9.15. That same $1 invested to match the median returns of active managers would turn into $10.03, or an additional 10% return.

Chart 1: Active and Passive Outperformance are Cyclical

Chart 1: Active and Passive Outperformance are cyclical

Loss Hurts More than Gain Helps

When investing in a passive index strategy, one is exposed to 100% of the market gains as well as 100% of the market losses. One of the key benefits of active management is the ability to limit downside capture. When investing, losses hurt long-term performance greater than gains help. To illustrate, if a $100 investment goes up 50% in year one, the result is $150; if the investment then goes down 50% in year two, the result is $75, even though the average annual return is 0%. Active managers that limit losses during a down market add significant long-term value to investors.

Nothing Works All of the Time

While there is no crystal ball to predict when active managers will outperform a passive approach, the herd-like rush into index investing seems to ignore some of the inherent risks that accompany a passive approach. Since stock market indices are market cap weighted, buying an index fund means buying proportionately more of the equities that have already increased in value indifferent to valuation or company fundamentals.

Experience and physics tell us that bubbles burst. For example, the Internet Bubble peaked in February, 2000 when the Information Technology sector represented 35.3% of the S&P 500 index; over the next 18 months, it declined by half to 17.7%. During the peak of the Financial Bubble, the Financials sector represented 22.5% of the S&P 500; it then fell to 9.9% two years later. Both of these corrections are periods when active managers contributed significant excess returns, as depicted in Chart 1 above.

Chart 2: Passive Biases over Time (S & P 500 Sector Breakdown)

Chart 2: Passive Biases over Time (S & P 500 Sector Breakdown)

Active for the Long Term

For long-term investors, we believe that active managers can provide upside gain and downside protection that result in better performance than passively relying upon the whims of the market. However, not all active managers generate long-term outperformance, which makes manager selection and due diligence a critical component of investing one’s assets. At Great Lakes Advisors, our team of experienced portfolio managers and analysts knows that there will be periods in the short term where our active approach might lag the index. However, the performance of the Great Lakes Large Cap Value Equity strategy over 3 years, 5 years, and 10 years all outperform the Russell 1000 Value Benchmark (see Chart 3), validating our belief that active equity management has a place in investors’ portfolios. 

Chart 3: Great Lakes Large Cap Value Equity Performance

Source: eVestment

About Great Lakes Advisors

Founded in 1981, Great Lakes Advisors is a Chicago-based investment manager with more than $8 billion in assets under management and advisement. We offer a wide range of quality fixed income and domestic equity strategies across all market caps, with additional SRI/ESG and tax managed capabilities. Our clients include public funds, multi-employer plans, corporations, religious communities, endowments/foundations, health care plans, and private wealth management clients. It is the mission of Great Lakes Advisors to be a collaborative partner in helping our clients attain their investment goals through proven actively managed strategies implemented by experienced skilled professionals and communicated with a focus on exceptional client service.

Pure gross performance has not been reduced by transaction costs for bundled fee accounts.

Bundled fee accounts are included in this composite and are defined as client accounts where Great Lakes Advisors maintains a direct contract with the client as opposed to a wrap fee platform sponsor, and the client has entered into a bundled fee arrangement with a custodian or broker-dealer which does not separately identify trading costs from other services covered by the bundled fee, typically including custody, consulting, administration and reporting. Gross composite performance is reduced by trading costs for non-bundled fee accounts but not for bundled fee accounts.

Prior to 1/1/12, net composite performance is pure gross performance after the subtraction of only investment management fees. Net returns are calculated by subtracting a 0.50  annual model management fee from the gross composite quarterly return, which results in a lower return than the actual investment management and bundled fees charged. Effective 1/1/12, Great Lakes Advisors adopted a new methodology to calculate net composite returns and actual investment management and bundled fees paid are now utilized. Additionally, a highest bundled fee of 2.50% in addition to the actual investment management fee is used for all accounts where the actual bundled fee is not known to Great Lakes. Bundled fees vary by sponsor, client, and strategy.

Great Lakes Advisors, LLC (“Great Lakes” or “GLA”) is an investment advisor registered with the Securities and Exchange Commission under the Investment Advisors Act of 1940.  Established in 1981, Great Lakes is a subsidiary of Wintrust Financial Corporation and a part of the Wintrust Wealth Management family of companies. On October 1, 2013, majority owned subsidiary Advanced Investment Partners, LLC (“AIP”) became fully-owned and integrated into Great Lakes. Great Lakes is a distinct business unit with distinct investment processes and procedures relating to the management and/or trading of investment portfolios for its clients.

The Large Cap Value Composite includes all institutional, discretionary, fee paying, total return portfolios managed with the Firm’s Large Cap value equity approach. For periods prior to 11/1/14, the Large Cap Value Composite also included all institutional, discretionary, fee paying, tax-exempt total return portfolios. The benchmark selected for comparison of returns for the Large Cap Value Composite is the Russell 1000 Value. Prior to 9/30/13, the S&P 500 and S&P 500 Value indices were also utilized in marketing materials. The two additional benchmarks were removed in all marketing materials after 10/1/13 to simplify the presentation, because the actual strategy is managed to the R1000V and because the majority of our clients only benchmark to the R1000V now. The Firm’s Large Cap value equity approach employs large and medium capitalization, principally U.S.-based equities with attractive earning power and favorable valuation. Portfolios subject to substantial client imposed restrictions are excluded from the composite. Accounts meeting the above criteria will be added to the Large Cap Value Composite the first full month of discretionary management. Accounts are removed from the composite, while retaining prior historical performance in the composite, at termination of the Firm as investment manager or when investment policy guidelines are instituted substantially restricting implementation of the value equity approach. Terminated portfolios will be removed from the Equity Composite after the last full month of active management. Accounts within this composite do not employ leverage. The composite inception date was June 30, 1990; and the composite was created on December 31, 1992. All cash reserves and equivalents are included in returns. Returns are time weighted and include reinvestment of dividends, income and gains. The value of assets and returns is expressed in U.S. dollars. Market commentary is available at or upon request. 

The benchmark selected for comparison of returns for the Large Cap Value Composite is the Russell 1000 Value (the large-cap value segment of the Russell 1000, consisting of the 1,000 largest companies within the Russell 3000 index. Frank Russell Company reports its indices as one-month total returns). Index returns are provided to represent the investment environment existing during the time periods shown. All indexes are fully invested, which includes the reinvestment of income. The returns for the index do not include any transaction costs, management fees or other costs. The indexes are not available for direct investment. Industry sectors are presented to illustrate the diversity of areas in which we may invest, and may not be representative of current or future investments. All holdings available upon request.

Great Lakes Advisors, LLC claims compliance with the Global Investment Performance Standards (GIPS® ). A complete list of firm composites and performance results, and the policies for valuing portfolios, calculating performance, and preparing GIPS compliant presentations are available upon request by calling 312.553.3700. Great Lakes Advisors, LLC’s fees are available upon request and may be found in our Form ADV Part 2A. Performance data quoted herein represents past performance. Past performance does not guarantee or indicate future results. All data is as of June 30, 2017 unless otherwise noted. Returns and net asset value will fluctuate. To determine if this strategy is appropriate for you, carefully consider the investment objectives, risk factors, and expenses before investing. 

Securities, insurance products, financial planning, and investment management services are offered through Wintrust Investments, LLC (Member FINRA/SIPC), founded in 1931. Trust and investment management services offered by The Chicago Trust Company, N.A. and Great Lakes Advisors, LLC, respectively. Investment products such as stocks, bonds, and mutual funds are not insured by the FDIC or any federal government agency, not bank guaranteed or a bank deposit, and may lose value. 

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