If you’re concerned that the economic impact of the COVID-19 pandemic will have a significant negative impact on the stock market in the coming months, this may be the time to consider switching from index funds to actively-managed funds.
While past performance is no guarantee of future results, and it’s too early to tell how this bear market is going to play out, as the Thrivent Mutual Funds Active vs. Passive Study demonstrated, the no-load actively-managed funds in the study did a better job of limiting losses than their corresponding indexes during those two market crashes earlier in the 21st Century.
To achieve even greater diversification, investors may consider actively-managed asset allocation funds, which offer broad diversification across multiple asset classes. While diversification does not eliminate risk, it generally helps reduce losses during steep stock market declines.
Here are several other reasons to consider switching to actively-managed funds:
- Flexibility. Due to the shifts in consumer behavior -- during and after the pandemic – the flexibility active managers have in reshaping their portfolios could prove particularly valuable during the recovery. Unfettered to a fixed portfolio, they have the ability to adjust their holdings to reduce the stocks or sectors that appear the most problematic. They can also use risk management techniques and diversification that seek to provide similar returns to the market with lower risk and volatility.
- A better chance to beat the market. The fact is, index funds perpetually trail the market by a small margin. Their costs, while minimal, create a small differential between the market performance and their own returns. As the study demonstrates, in any given year, actively-managed funds can, and have, outperformed the market.
- Limiting market losses can speed up your recovery. Actively managed funds may not always cut your losses, but if you are successful in reducing your losses in a down market through an actively-managed fund, the road to recovery becomes much easier. In fact, the bigger the loss, the more difficult it becomes to recover from that loss. For instance, for a 5% loss, you would need a gain of 5.26% to restore your portfolio to its previous level. But with a 20% loss, you would need a gain of 25% to get back to even; a 30% loss would require a gain of 42.9% to fully recover; and a 50% loss would require a 100% gain to bring the portfolio back to its previous level.
In terms of pure long-term performance, index funds may (or may not) have a slight edge. But when the chips are down and the markets are reeling, the Thrivent Mutual Funds study suggests that you may be better served to have an active manager in your corner making the crucial decisions.
The tables below summarize some of the key results of the study during the Dot-Com Crash, the Great Recession crash and the decade of 2000 – 2010.
The table headings include: Lipper funds category (“large cap core” or “small cap core”), Index (S&P 500 or Russell 2000), the four performance quartiles (the higher the percentage the worse the relative performance), and the Average Percentile Ranking.
The Average Percentile Ranking is not tied to the quartile rankings, and provides a different vantage point on the comparative performance. It measures the average percentile of how they ranked over the given period of time. As with the quartile rankings, a lower percentage indicates better performance while a higher percentage indicates worse performance. For example, in the Dot-Com Crash table below, the average percentage of the S&P 500 was 70.6%, which put it in the bottom 30% among all funds in that category. The Russell 2000 Index fared even worse with an 81.9% average percentage – which means it would have ranked in the bottom 18.1% of funds in the small cap category.
In the following charts, please keep in mind that the top quartile represents the best performance and the bottom quartile represents the worst. For example, in the first table entitled “Dot-Com Crash,” you will see “0.0%” in the top and 2nd quartiles for each of the two indexes. That indicates that neither the S&P 500 nor the Russell 2000 would have ranked in the top half (top or 2nd quartiles) in performance in their respective actively-managed no-load fund groups during a single 12-month period from Sept. 31, 2000 through March 31, 2003.