Making Better Financial Decisions

The Bear Market: Hibernate Or Rebalance With Active Funds?

by Glen Hawkins

During the current bear market, you may be questioning whether a passive or active investment strategy will help you achieve your financial goals. The debate over when and if active fund management outperforms passive fund management rages on.

While passive funds have been widely reported to deliver a superior risk-adjusted investment, the bear market is shining new light on active performance management. Here's why many financial model portfolio building services will recommend a mixed portfolio of active and passive funds. 

Improved Risk Control 

Even during the long bull run, the young, upwardly affluent investor typically prefers some active management exposure, while more conservative retirement portfolios have gone 100 percent passive. If you're on the conservative end of the risk spectrum, you may be missing opportunities to protect your downside risk. 

When in bear markets, active managers have the advantage of being able to tactically maneuver. Owing to their ability to rebalance a portfolio to preserve an investment portfolio's value, active funds: 

  • are less volatile over time
  • ​have lower risk-adjusted returns (how much risk is taken for each dollar of return)
  • have lower drawdowns in bear markets

Although passive funds do not have the ability to actively protect against downside risk, historically, diversification has been a sound strategy. 

Portfolio Rebalancing 

The lower risk profile of active funds is largely due to the ability to actively rebalance a portfolio. When an economy is in a severe recession, company outlooks can change. Active managers who more actively screen companies will be naturally inclined to do more portfolio rebalancing when red flags such as over-leverage or cash flow issues arise.

They can also opportunistically move into new sectors. New emerging areas of biotech, for example, have high growth opportunities. The ability to put more money in cash and move out of more volatile equities is another risk control strategy. 

Asset Mix 

The active versus passive debate may be misguided after all. The choice of asset class diversification is 10 times more important than choosing between active and passive investment strategies, according to a recent study. The study, which concluded that active funds outperform passive funds over a 20-year period, uniquely focused on long-established active funds.

Investors need to change their mindset about active funds as a growth strategy. If you seek to limit your downside risk, active management is also a risk management strategy. For even the most conservative portfolio, there is a place for some active exposure when financial model portfolio building. 

To learn more, contact a resource that offers financial model portfolio building services.