Masters of Their Domain

In the obscure world of high-stakes professions, there exists an elite group, whose members command salaries north of $700,000 per year. These individuals, akin to a specialized military unit, are deployed throughout the world on a moments’ notice with a level of domain expertise rivaling the world’s finest business strategists and leaders. With a mastery that blends technical prowess, astute decision-making, and unparalleled local knowledge, they navigate complex, dynamic environments where the stakes are monumental.

This description may evoke images of Wall Street tycoons or Silicon Valley innovators, however, today we are talking about river pilots much like those of the Crescent River Pilots’ Association in Louisiana who exhibit their exceptional skill each day in guiding colossal vessels along the perilous waters of the Mississippi and its tributaries.

Navigating the Currents of Investing

The Mississippi River, notorious for its daunting and winding tributaries, presents substantial risks. Pilots contend with currents so powerful they can fill the Superdome in 90 seconds, and river depths that change unpredictably. These pilots often face zero-visibility fog while transporting volatile cargo with the explosive power of a 6-kiloton bomb. Their role demands not just technical skill but also acute time management and effective communication across language barriers, reflecting a role that is both physically demanding and intellectually rigorous.

Our focus on the river pilots of the Crescent River Pilots’ Association is not to diminish the role of cargo and passenger ship captains who navigate their vessels on the open seas. They have a mighty responsibility ensuring the safety of cargo, passengers, and the environment in which they operate. The purpose of our focus, instead, is simply to highlight the unique sub-specialties that necessarily exist even within seemingly similar fields.

Investment management happens to be quite similar. The active versus passive management debate is a common area of inquiry among clients. Active management involves a hands-on approach where fund managers make specific investments, aiming to outperform the market. Passive management, conversely, follows a market index, focusing on long-term investment with minimal trading. Typically, investors are asked to pay a premium for active management in the form of higher expense ratios in exchange for the manager’s expertise, while passively managed strategies are more conducive to minimizing fund expenses.

The Value of Active Management

Actively managed investing, much like the expert navigation of a river pilot, is a sophisticated and proactive approach that combines deep market knowledge with agile responsiveness to navigate the complex currents of the financial world. Active managers, akin to pilots skillfully steering through treacherous waters, utilize their expertise to interpret market dynamics, seize short-term opportunities, and mitigate risks through diversified portfolios. While offering the potential for higher returns, this strategy also allows for personalized investment strategies tailored to individual goals and risk profiles.

Active managers conduct in-depth research and engage in shareholder activism. Particularly effective in specialized or less efficient markets, active management is an art that demands skill, experience, and a strategic mindset, promising a unique and bespoke investment journey in the ever-evolving financial landscape.

The Value of Passive Management

Passively managed investing, much like the steady and consistent course of a large vessel on the open sea, is characterized by its long-term, strategic approach. This method, mirroring the dependable trajectory of a seafaring captain, involves aligning with a market index, focusing on the broader horizon of investment goals rather than the short-term fluctuations. In this approach, the steadiness and predictability of the market’s overall direction are favored over the rapid maneuvers of active management.

Passive strategies excel in providing a low-cost, efficient path for investors, akin to a captain’s reliance on the vast and steady currents of the ocean to reach a distant destination. Over extended periods, this approach often proves beneficial as it avoids the pitfalls of attempting to outperform the market. The passive strategy is particularly effective in well-established and predictable markets, such as Large-Cap stocks, where the course is clearer and more stable. In essence, passive management offers a less complex, more cost-effective way to navigate the financial markets, emphasizing the value of long-term consistency and stability in charting a course towards investment success.

Recent Trends in Active and Passive Management

The past couple of years have demonstrated that turbulent markets can mark opportunities for active investment managers, however, the long-term data still indicates that passively managed options are especially compelling for planning horizons beyond 5 years.

Over the past year, active management experienced a resurgence, marked by a significant proportion of active strategies outperforming their passive counterparts, particularly evident in Small-Cap, Mid-Cap, Foreign Equity, Real Estate and Bond asset classes. However, these effects dwindle rather quickly as the time horizon is extended.

Passive management, with its steady, long-haul approach, continued to be the preferred strategy for many long-term investors. Despite active management’s short-term success, over a 10-year span, passive strategies generally maintained an upper hand, especially in U.S. Large-Cap and Foreign Developed asset classes. This trend underscores the inherent challenge for active managers to consistently outperform the market over extended periods.

While active management demonstrates remarkable performance in the short-term, passive management maintains its dominance in long-term investment scenarios. This dynamic reflects the nuanced choices investors face: the agility and potential for higher returns with active management versus the steady, cost-effective approach of passive strategies, each playing a unique role in the broader narrative of investment strategy.

Figure 1. The % of Actively Managed Funds Beating Their Indexes Across Multiple Time Periods

American Trust: Balancing Active and Passive Management

At American Trust, we understand the intricate dance between active and passive manager selection, much like a skilled captain who knows when to harness the wind’s power and when to rely on the steady current. Our philosophy is to create a harmonious balance between the two, recognizing that each has its unique strengths and plays a vital role in a well-rounded investment portfolio.

We recognize the allure of active management, especially in its ability to navigate the complex and often turbulent waters of certain markets like Fixed Income, Real Estate, and specialized equity styles. In these areas, the expertise and agility of active management can be particularly valuable, much like a skilled pilot deftly maneuvering through challenging river bends. For income focused investors or investors with shorter time horizons, active management can be an effective risk management tool as much as, if not more than, a source of higher returns.

Conversely, we appreciate the steady and long-term benefits of passive management. It’s not just about the lower cost; it’s also about the historical difficulty active equity managers have in consistently outperforming the market over extended periods, particularly in timeframes beyond five years.

In implementing this balanced approach, American Trust focuses on thoughtfully integrating the benefits of both active and passive management. We believe in “paying up” for active management where it shows clear value, such as in more complex or short-term investment scenarios. At the same time, we advocate for the cost-effective and consistent approach of passive management for most equity investments.

This balanced strategy allows us to accommodate the unique needs and preferences of each client, ensuring that we navigate the financial markets with a tailored approach that maximizes potential and aligns with individual goals.

Conclusion

At American Trust, it is our privilege to guide our clients through these financial waters, blending the art of active management with the steadiness of passive strategies to achieve their investment objectives. While we emphasize low costs, we recognize the value of active management in certain areas. Our approach balances these approaches, providing flexibility and adaptability to meet each client’s unique needs.

American Trust is honored to serve our clients, offering a balanced, thoughtful approach to investment management. We invite our clients to engage with their Fiduciary Investment Advisor for any queries or updates, as we navigate these financial currents together, much like the skilled river pilots of the Mississippi.