WHY ACTIVE MANAGEMENT?

In times when the market is moving up on a steady basis, we are often asked why not just use a buy and hold approach?  It is a very good question and one that the financial media often espouses.  It should be noted that the financial media is largely supported by the advertising dollars of the financial industry which would love nothing more than for investors to buy their funds and hold to perpetuity!  However, not to be completely jaded, let's take a look to see if the buy and hold mantra holds true in actual real life situations. 

Let's say that an investor has $100 to invest and an 8 year time frame.  Furthermore, let's assume that the markets follow the usual trend of 3 up years for every 1 down year.

The market returns are:

Yr. 1     10%
Yr. 2       5%
Yr. 3     15%
Yr. 4    -25%
Yr. 5     15%
Yr. 6       5%
Yr. 7      15%
Yr. 8     -15%

Adding up the returns it appears that you have made 25%.  However, the math works much differently.

Yr 1	$110.00
Yr 2	$115.50
Yr 3	$132.83
Yr 4	$99.62
Yr 5	$114.56
Yr 6	$120.29
Yr 7	$138.33
Yr 8	$117.58

In actuality, because of the effect of losses on the portfolio, the value has gained only 17.58% over the 8 years. Furthermore, it does not matter in which year the losses occur - the results remain the same.

With active management, the advisor seeks to capture some portion of the gains while avoiding the losses.  What would happen if an investment professional were able to capture 75%, 60%, 50% and 40% of the gains in the up markets while avoiding 75% of the down markets?


                      75%         60%         50%         40%

Yr 1	107.50	106.00	105.00	104.00
Yr 2	111.53	109.18	107.63	106.08
Yr 3	124.08	119.01	115.70	112.44
Yr 4	116.32	111.57	108.47	105.42
Yr 5	129.41	121.61	116.60	111.74
Yr 6	134.26	125.26	119.52	113.98
Yr 7	149.37	136.53	128.48	120.82
Yr 8	143.77	131.41	123.66	116.28

As you can see from the table above, capturing as little as 40% of the gains in the up years would yield almost the same level of portfolio gains over the 8 years as a buy and hold investor.  Furthermore, a huge benefit of the active management approach would be the lessened stress and ability to sleep through the bad markets without seeing your portfolio drift down 10, 15 or 25% not to mention the unfortunate investor that had a need for his/her assets in the midst of a bad year like year 4.  Oftentimes, a picture is worth a thousand words.

 


So to answer the question posed by this post - why active management?  Why would an investor choose any other way?  Over time the benefits speak for themselves and Bills Asset Management has a 20 year history of effectively employing active management techniques.