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Passive aggression: active funds could soon show their worth

Cattle skull in desert, Windhoek, Namibia, Africa

If money managers stopped investing actively, that would be the end of IPOs. Fortunately, there's bad news.

Bashing actively managed funds has become a popular pastime during quiet weeks in financial markets.

"Most active fund managers failed to outperform indexes in 2021," reads a recent article from Reuters. Something similar could have been written, and probably was, in most years of the past decade or so.

And if it has been unusual for managers to do better than a passive fund in one year, it was even rarer for them to do so consistently. Investors, it appears, should stay far away from charlatans claiming to have any sort of strategy for outperformance.

But if no one buys or sells stocks based on their own analysis — or even speculation — then there can be no price discovery. This would be catastrophic for initial public offerings, which are, by definition, not yet part of any index.

If there were no active managers, it would be impossible for new companies to raise equity, which, surely, is the whole point of having equity capital markets in the first place.

But studies looking only at the past ten to fifteen years of fund performance miss a lot. We have gone through a suspiciously long economic upswing in an era of low interest rates.

Looking back further, a Nomura Securities analysis showed that when interest rates were rising in the US in the 60s, actively managed funds actually outperformed the S&P 500.

And Robert Kosowski, a finance professor at Imperial College in London, found in 2011 that over 50 years, mutual funds performed well, compared to risk, during times of recession.

So while market participants keep a worried eye on central bank policy makers, a hawkish turn by the Fed and the ECB might not be such an unqualified disaster after all.

IPOs may have to navigate more difficult surroundings as they tighten the purse strings, but if higher interest rates and bearish signals remind the markets of the purpose of active investing and halt the relentless march of passivity, at least they will still be able to take place.

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