Why We Believe in a Symbiotic Active/Passive Investment Approach

By Robert Bacarella | March 8, 2018

After coming off a banner year in 2017 with the Dow Jones Industrial Average gaining 25%, some investors were caught off guard by the onslaught of market volatility in early 2018. In this environment—as in nearly all environments—we think it’s clear that investors are wise to stay invested in the market while being prepared to weather potentially higher volatility. We’d say the same thing even if storm clouds were looming larger, because the opportunity cost of getting out of the market can be high. Investors who shift to the sidelines miss potential further gains—as a downturn may not come—and, in the event the market does correct downward, they risk missing out on a subsequent upturn.

In our view, the best way to stay in the market—year in and year out—is for investors to bring together passive and active approaches in their portfolios, as our Monetta Young Investor Fund is designed to do in one investment vehicle.

The Reality

While the debate over active versus passive management wages on, the reality is that, on average, 90% of actively managed funds have underperformed their benchmarks over the past 15 years. Even worse, large-cap growth managers underperformed 95% of the time.

In our view, we think many active managers overemphasize stock selection, looking for a needle in a haystack. With index investing, you’re buying the haystack and creating a certain level of consistency.

Another challenge for many traditional active managers is market timing. It is extremely difficult to predict future market or stock price movements for a wide variety of reasons, including the fact that both are driven by human behavior and humans are irrational. As Isaac Newton famously said after losing his fortune in the 1720s over stock speculation, “I can calculate the motions of heavenly bodies, but not the madness of men.” At Monetta, we avoid market timing, knowing that investors who try to time the market generally underperform those who remain invested.

A Symbiotic Approach

This is not to say that there aren’t benefits to active management. We often equate investing to flying a plane. For much of the flight, the pilot has the plane in autopilot—that’s passive investing. But for take-off, landing, and times of turbulence, the pilot is very much needed.

In our view, the wise course is a balanced one: choose both. Anchor a portfolio with an allocation to one or more passive investment strategies that give broad exposure to U.S. stocks. Doing so provides a measure of confidence that with a portion of your portfolio you will in all likelihood achieve an average market return. Pair this passive allocation with an active approach—and be prepared to shift the allocation percentages to each according to market conditions.

The active allocation offers the potential to add alpha while making the portfolio’s overall performance less dependent on stock selection and timing. At Monetta, our active allocations are to a concentrated group of large-cap companies, which are generally well-known, household names. Stocks of this nature have tended to weather downturns better than the market as a whole. Within the large-cap universe, we seek quality, growth-oriented companies that demonstrate positive relative strength, improving guidance, strong management, positive cash flow, and other factors.

We’ve been employing our somewhat unconventional active/passive investment approach since December 2006 with the Monetta Young Investor Fund. And while much of this period has consisted of a fairly stable, prolonged bull market, we were tested in 2008 and stand ready to be tested again should volatility return.

Regardless, there isn’t an “ideal market environment” for a balanced active/passive strategy—that’s the beauty of it. In our opinion, it really is the best of both worlds.