This is a nuanced discussion. The value of active management is in managing downside risk. Active mutual fund management is not the same as active management by a professional investment adviser.
- Mutual funds. Active, stock-based mutual funds have only limited tools to manage risk – they have an investment policy to always stay fully invested, even in a bear market. If history is a guide, active mutual funds can mitigate, but not avoid, severe downside in their target market.
- Investment advisers. Active investment advisers and wealth managers do not have such a mandate. Advisers have much more flexibility to sidestep a bear market. They can use mutual funds and ETFs to get exposure to a certain asset class or index when they need it, and divest when they don’t. If a bear market does emerge, an adviser can move his client to cash, or to lower-risk ETFs.
- Hedge funds. Hedge funds, like financial advisers, have much more flexibility than mutual funds, but focus on highly specific niches. Hedge funds actively manage downside risk, and may provide an uncorrelated (i.e., diversifying) return to an investment portfolio otherwise invested in stocks and bonds.
Sprout Capital Management, LLC is a registered investment adviser that actively manages client portfolios.