Is Opting for Active Strategies Over Passive More Advantageous in Today’s Market?
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SIMON BROWN: I’m speaking with Luigi Marinus, who leads the discretionary fund management team at PPS Investments. Thank you for joining me this early in the morning.
In a recent article you published, you discuss how we are currently experiencing a golden age of passive investing. It’s notable that a few years ago, passive strategies surpassed active mutual funds in the US. The data indicates that active funds are finding it challenging to outperform the index. However, you also emphasize that this success has been supported by favorable conditions—low interest rates, minimal inflation, and substantial market liquidity.
It’s important to note that these conditions don’t always persist. As the landscape changes, we may need to reevaluate our perspectives on passive versus active investing.
LUIGI MARINUS: Good morning, Simon. You are absolutely right. We can’t overlook the success of passive investing lately. It has also benefited from being relatively low-cost in comparison to active management.
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The key takeaway is that conditions can indeed change. We usually advocate for a blend of passive and active approaches in discretionary fund management (DFM) strategies. We need to proceed with caution because overvalued stocks tend to become even pricier, but this trend can reverse.
The suggestion is to avoid solely investing in passive strategies and instead maintain diversified exposure across various asset classes.
SIMON BROWN: I understand your point. I appreciate that you mentioned the importance of a blended approach, and we’ll revisit that shortly.
However, presently, one of the challenges with passive investing is the increasing concentration. We have witnessed significant concentration in tech and AI stocks. Moreover, let’s not overlook the local market concentration—only ten stocks represent half of the index.
Additionally, while we often celebrate good valuations as prices rise, they can pose risks as well. This potential danger to passive investing arises from the fact that upward trends can’t last indefinitely.
LUIGI MARINUS: Exactly, Simon. The primary driver of passive investing is momentum, which is largely characterized by the largest and most expensive stocks becoming even more pricey.
That works well under certain market conditions, as you mentioned, and that has certainly been the trend over the past few years.
What I would propose is a shift in our thinking. Consider the long-standing debate between value and growth investing—we know that value investing performs well for a time and eventually reverts, and vice versa.
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So, this cyclical nature is a framework for understanding active and passive investing. The key distinction is that management costs are somewhat comparable. With cheap segments of the market performing well, some are questioning the necessity of paying attention to the other side.
Nonetheless, it’s likely that we will witness a turnaround eventually, in line with the typical cyclical behavior of markets. Our message is simply to stay alert and cautious, as such reversals can occur.
SIMON BROWN: Absolutely. I understand. You emphasize the importance of core beta exposure, which is indeed fundamental to passive investing.
However, there are times—possibly like now—when we should consider altering that exposure. I appreciate your value versus growth analogy. The goal isn’t to withdraw completely but rather to redirect some emphasis towards active strategies as the market dynamics are different from what we’ve seen in the last decade.
LUIGI MARINUS: Yes, we believe that’s the case. The global question surrounding AI is whether it’s forming a bubble or not, which is hard to predict. However, it’s likely that there will be winners and losers.
If you have an active manager who can identify potential winners and losers, they might achieve better results compared to a passive investment that distributes funds across the board, irrespective of performance expectations.
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Thus, there’s significant value in having active managers utilize their discretion, particularly when valuations are steep, allowing for more strategic investments rather than indiscriminately purchasing high-priced stocks. Adjusting this approach could prove beneficial moving forward.
SIMON BROWN: Absolutely. You make an excellent point. We’ve touched on this, but it’s worth reiterating that passive investing often gravitates towards the latest trends. SpaceX serves as a recent example.
As an active investor, you might evaluate SpaceX’s valuation skeptically, questioning its viability, whereas a passive investor would jump in regardless.
LUIGI MARINUS: Exactly, and that’s inherent to passive investing, which has yielded favorable results over the past several years, both locally and internationally—likely even more so on a global scale.
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Nonetheless, as you mentioned, we’ve observed many formerly high-flying stocks becoming even hotter, which—combined with lower fees—explains why investors are enthusiastic about this segment of the market.
However, I think it’s essential to engage in some rational analysis and assess the inherent risks involved.
SIMON BROWN: Indeed. The hottest areas in the market are becoming more extreme. That is concerning, and it’s definitely something to be wary of.
We’ll conclude our discussion here. Thank you, Luigi Marinus, head of discretionary fund management at PPS Investments, for your insights this early morning.