Points to Consider About Active Management

December 11, 2015

Are you better off investing in an actively managed account or a passively managed index fund? That question has been the subject of much debate. While news reports give statistics showing that index funds have outperformed the average actively managed stock fund, those figures don't tell the complete story.

Look Beneath the Surface -- Some experts believe the success of index-based management has been a direct consequence of the favorable economic environment of the '90s. If present conditions prove unsustainable, active stock selection may offer greater potential opportunities.

Returns and Risk -- You should also be aware that performance figures often do not adjust for risk. An actively managed fund may appear to have underperformed a fund that mimics a market index such as Standard & Poor's Composite Index of 500 Stocks (S&P 500), but it may have actually outperformed the index when adjusted for risk. For example, a fund with a beta of 0.76 may post a rate of return that is lower than its benchmark. But with less risk than the benchmark (as reflected by a beta of less than 1.00), this fund would expect to have more modest returns. This fund could be seen as performing well if its actual return were greater than its expected risk-adjusted return.*

Expected return = risk-free rate of return + (beta X the risk premium)

The risk-free rate of return is defined as the return on the safest asset available in the market, normally Treasury bills. The risk premium is the difference between the risk-free rate and the prevailing market return for the fund class, normally as measured by a benchmark like the S&P 500. Beta is a measure of how volatile a mutual fund's net asset value (NAV) is compared to its benchmark; the higher the beta, the wider the range of the fund's changes in NAV.

Greater Flexibility -- Active managers can take proactive steps to reduce risk during market downturns, including reallocating assets or moving to less-risky portfolio structures. In contrast, an index fund mirrors an index, and returns will rise or fall in step with the underlying benchmark.

Given the level of volatility in the U.S. stock market in recent years, an active management approach may provide greater comfort to investors and offer an opportunity for greater control.

For additional information, call Washington Trust Wealth Management at 800-582-1076.

The opinions expressed in this newsletter are those of the author and may not reflect those of The Washington Trust Company. The information in this report has been obtained from sources believed to be reliable, but its accuracy and completeness are not guaranteed. Any opinions expressed herein are subject to change at any time without notice. Any person relying upon this information shall be solely responsible for the consequences of such reliance. Performance is historical and does not guarantee future results.

*The return shown is based on historical results and is not indicative of future performance. Calculations assume reinvestment of capital gains and dividends. Investment return and principal value will fluctuate, so that an investor's shares, when redeemed, may be worth more or less than their original cost. Performance would have been lower if fees had not been waived. Individuals cannot invest directly in any index. The performance of any index is not indicative of the performance of any particular investment. Results do not take into account the fees and expenses involved with investing in stocks

Connect with a wealth advisor

No matter where you are in life, we can help. Get started with one of our experts today. Contact us at 800-582-1076 or submit an online form.

Contact us

This material is presented for informational purposes, and nothing herein constitutes legal, accounting, or tax advice. Please consult with an attorney or tax professional regarding your specific financial, legal or tax situation.

The views expressed here are those of Washington Trust Wealth Management and are subject to change based on market and other conditions. Investment recommendations and opinions expressed in these reports may change without prior notice. All material has been obtained from sources believed to be reliable, but its accuracy is not guaranteed.