Zero percent interest rates and low market volatility are gone, and so is the case for passive investing in the current rocky market environment. Ignore these warnings, say active managers, at the risk of losing a boatload of money in the next lost decade.

Thanks in part to low interest rates and volatility, passive investing styles have been ascendant during the past decade. But AllianceBernstein and Natixis Investment Managers, among other active management firms, say the passive sweet spot is disappearing.

“Like low rates, low levels of volatility have contributed to consistent investment returns over the past ten years. But as rates rise, many foresee a return to historical norms that make volatility a more significant factor,” according to the 2018 Natixis investment outlook.

“Higher volatility translates to higher dispersion, which works in favor of active managers,” said Richard Brink, senior vice president and market strategist in the client group for AllianceBernstein. “But it also tends to create more challenged market conditions. This landscape leaves a lot of space for active managers to add value.”

And active managers would like to fill up a lot more space after the past decade’s massive inflows into passive funds at the expense of active funds.

Indeed, in 2007 flows into passive funds were slightly ahead of active fund flows to the tune of $8.6 trillion to $7.2 trillion, according to Morningstar, which excluded money market funds in its tabulation. But that gap has significantly widened: last year saw flows of $18.1 trillion into passive funds versus $11.4 trillion for active funds.

But active managers posit the recent dominance of passive investing could mislead many advisors and investors into thinking that passive investing is a proverbial slam dunk method of success. They point to this century’s first decade, a period bracketed by two market bubbles that burst.

Real returns in U.S. large-cap stocks suffered average annual losses of 4.21 percent between the end of 1999 and the end of 2009, while U.S. small caps lost an annual average of 0.09 in that time frame, according to Thornburg Investment Management.

Alpha And Beta

AllianceBernstein says the relationship between alpha (superior performance) and beta (market risk) is what makes the difference in the battle between active and passive styles. The higher the volatility, the higher the dispersion, “which works in favor of active managers,” Brink said. “The great rising tides of these markets make individual boats less important—even when they’re better boats.”

Investment managers at a recent press conference sponsored by Natixis predicted that 2019 will be a good year for active management.

“It will make the case for active management,” said Andrea DiCenso, a co-portfolio manager for Loomis Sayles, who spoke at the conference.

She is part of a group of investment managers who are trying to make the case for active management. They warn that passive investing will result in an investor slaughter during a protracted bear market.

They say the investing norms of the past decade were based on cheap money created by central banks and relatively low volatility, both of which no longer apply. Central banks are now raising rates, and the markets have been whacked by volatility in the fourth quarter and many people expect that more could be in store in the near future.

Not So Fast . . .

Despite the stars now seemingly aligned for active managers, an industry observer says everything isn’t perfect for active management.

Ben Johnson, director of global ETF research at Morningstar, says the talk of active management making a comeback smacks of market timing, which he warns is moonshine. Johnson has studied the longer-term track record of active versus passive performance, and has found there are a few instances where active funds outperform indexes. In most cases, he says, actively managed funds with low costs are the ones that tend to perform well.

Although active managers say the future is now for their investment management approach, Johnson noted in Morningstar’s Active/Passive Barometer report that their recent numbers are poor.

“The one-year success rate among active U.S. stock-pickers declined relative to year-end 2017. Just 36% of active managers categorized in one of the nine segments of the U.S. Morningstar Style Box both survived and outperformed their average passive peer over the 12 months through June 2018,” according to the report.

Nonetheless, Johnson agrees that greater dispersion gives some active managers a better chance to beat the indexes.

“There are indeed good active managers," he said. "But they tend to be far and in between.” He warns that it can be difficult to identify these performers because they might dodge one market crash—thus burnishing his or her reputation—but then run into problems in another downturn.

“The idea of a stock picker’s market belongs in the same category as a man in a big red suit who puts presents under your tree,” Johnson said.