In recent years, passive investing has been gaining popularity with investors as a more cost-effective and reliable investment strategy.
However, despite the evidence that in aggregate, passive funds outperform active funds, active management in equity mutual funds has remained a popular investment strategy. A recent survey conducted by (Choi and Robertson 2020) aimed to explore the reasons why investors continue to buy actively managed funds and investigate whether investors are misperceiving the relative returns of active versus passive management or are overconfident about their ability to select outperforming active managers.
Understanding Actively Managed Mutual Funds
Before we delve into the reasons why investors continue to buy actively managed funds, let's first understand what they are. Actively managed mutual funds are funds managed by a professional fund manager who actively buys and sells securities within the fund with the aim of outperforming the market. The fund manager's goal is to beat the benchmark index, such as the S&P 500, and generate higher returns for investors.
In contrast, passive funds track a particular market index, such as the S&P 500, and aim to mirror its performance. Passive funds are managed by algorithms and require less expertise, which makes them more cost-effective and less risky than actively managed funds.
The study surveyed investors to determine the factors influencing their decision to invest in actively managed equity mutual funds. The survey asked respondents about their knowledge of mutual funds, the factors influencing their decision to invest in active funds, and their beliefs about active management versus passive management.
Factors Influencing Investment Decisions
The study found that investors are primarily motivated to invest in actively managed equity mutual funds due to their belief that active funds would provide higher returns on average and the recommendation of a financial adviser.
A significant proportion of investors also expressed support for hedging demand, which suggests that they expect actively managed funds to deliver higher returns when the economy is performing poorly.
Beliefs About Active Management
Regarding the assessments of Berk and Green (2004), the respondents agreed that past returns were evidence of skill, with 46% agreeing or strongly agreeing with the statement.
However, only 18% agreed or strongly agreed that there were decreasing returns to scale in active money management. Interestingly, high-wealth respondents were more likely to believe that high past returns were strong evidence of skill and that there were decreasing returns to scale in active money management.
Implications for Investors
The findings of the study have important implications for investors. Investors should be aware of the evidence that passive funds outperform most actively managed ones and carefully consider the reasons why they invest in actively managed funds.
Investors should be cautious about the recommendations of financial advisers and should understand the importance of passive funds in retirement savings plan investment menus.
Investors should also be mindful that past returns are not always a reliable indicator of future performance and that there may be decreasing returns to scale in active money management. Additionally, investors should be aware of the factors that influence their investment decisions, particularly when it comes to actively managed funds, and make informed decisions that align with their long-term investment goals.
In conclusion, investors should be aware of the evidence that passive funds outperform most actively managed ones and carefully consider the reasons why they invest in actively managed funds. By being informed and aware of these factors, investors can make more informed investment decisions and achieve their long-term financial objectives.
This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.