Coke vs. Pepsi. Home Depot vs. Lowe’s. LeBron James vs. Michael Jordan.

While these comparisons often provoke debate (sometimes heated) about which is better, we don’t actually have to fall hard onto one side or the other. Coke and Pepsi both have their place in our culture, with both soft drink brands having won legions of loyal consumers.

Home Depot and Lowe’s complement each other—personally, I like Home Depot’s selection of wood, tools, and nuts and bolts, and I turn to Lowe’s for home finishings.

And, when comparing the skills and careers of LeBron James and Michael Jordan, both basketball legends are impressive players—but they’re different men, and from different eras. Besides, LeBron is still playing, while Jordan is retired.

The point is that these comparisons appear to ask people to make a choice between two options, when in fact, both options have respectable strengths and can easily coexist. The same is true of the historic debate between active and passive investment management approaches.

Despite greater inflows to passively managed mutual funds over the past year, the hybrid active/passive approach is gaining traction. Morningstar Direct data indicates that investors pulled $879 billion in assets from active mutual funds during the first 11 months of 2022, and added $51.6 billion to passive mutual funds. However, these assets are primarily from mutual fund trades by institutional and retail investors—and our observations indicate that financial advisors are continuing to invest in both active and passive funds.

According to Envestnet Analytics data, 50% of inflows to mutual funds and ETFs in Envestnet’s advisor-managed program and unified managed account program during the 12 months ending December 31, 2022 were to active funds, and 45% of inflows from the advisors on our platform during that time went to passive funds.

It is understandable why advisors are continuing to allocate to a mix of active and passive funds. Active and passive management both have advantages and disadvantages. Typically, active managers offer investors the opportunity to outperform an index, and the flexibility to adapt to changing market conditions. On the other hand, active management success depends on the ability of the manager, and some are better than others. Active management fees are also higher than their passive counterparts because active managers can charge for research and security selection.

Passive management fees are often lower because the security selection process is usually automated, given that the objective is to match an index’s returns instead of outperformance. While the performance of a passively managed fund will be in line with the performance of the index, that can work against investors during volatile market conditions. Since the portfolio manager is mirroring an index, they often don’t have the flexibility to adapt to changing market conditions.

Actively and passively managed funds tend to perform better in different types of market environments, just as certain asset classes can be better suited to various market conditions. For example, active funds have historically performed better during more volatile and down-trending markets, and with assets that have lower correlations and are more inefficient. Passive funds, on the other hand, have historically tended to perform better in less volatile and up-trending markets, and with asset classes that have higher correlations and are more efficient.

Analysis of actively and passively managed funds focusing on specific asset classes demonstrates that certain asset classes perform better, across market cycles, under either active or passive management. Envestnet’s research of alpha distribution of all active mutual funds, both alive and dead, in Morningstar’s database from January 1980 to April 2018, which was updated in March and April 2022, has uncovered that the domestic large-cap core asset class has been a difficult area where asset managers can shine, while domestic and foreign small-cap asset classes tend to perform better under active management.

Investors can clearly benefit from both active and passive management styles. This is why some investment management platforms and providers have begun offering portfolios that incorporate aspects of both active and passive management. These active/passive portfolios tend to include exposure to actively and passively managed assets overseen either by vetted third parties or by the providers themselves, based on research into which asset classes tend to perform better under active or passive management. Portfolios that seek to combine active and passive management can also be offered through investment vehicles like exchange-traded funds (ETFs), which can be more cost- and tax-efficient for investors (as well as more liquid and transparent).

So, like Coke and Pepsi, and Home Depot and Lowe’s, both active and passive management have their place, and comparisons between the two no longer need to have an “either/or” conclusion.

Brooks Friederich is principal director of research strategy at Envestnet | PMC, Envestnet’s portfolio consulting group.