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.”

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