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By Christine Benz | 09-16-2011 06:00 AM

Beyond the Active-Passive Divide

Hear Morningstar investment specialists' take on the debate and learn how to get the most out of your active and passive investments.

Christine Benz: Hi. I'm Christine Benz for, and welcome to our roundtable on getting the most out of active and passive strategies.

I'm happy to say that we've got a great lineup of individuals to help us do a deep dive into this topic.

Mike Breen is here today. Mike is associate director of fund analysis for Morningstar.

Scott Burns is also here. Scott is director of exchange-traded fund, closed-end fund, and alternative fund research for Morningstar.

And last but not least, John Rekenthaler is here. John is vice president of research for Morningstar.

Thank you all for being here.

So, we were thinking that we didn't want to have a cage match here, because I think, we all…

Scott Burns: … Is that because you thought I'd win?

John Rekenthaler: He is the largest; I would bet on him.

Benz: (Laughing) So, I think, we can all agree, though, that there are a lot of shades of gray in this debate. John, I'm hoping you can set the stage by discussing the lay of the land in terms of what the data tell us about active versus indexing strategies. Are you better off just indexing and calling it a day?

Rekenthaler: Yes and no.

I mean, there is no question that when you look out across the fund categories, five-, 10-, 15-year timeframes, because in short timeframes anything can happen. We can talk about that, too, but over the longer term, that for most categories a low-cost index fund is going to outperform most of the active funds.

So, there's 200 active funds in the category. Typically, it depends on the time period and the category, but maybe about two-thirds of the funds will trail a low-cost index. So, that's well known, and that's a clear win for indexing overall. What's less well known though is, it doesn't always work out that way. In fact, very much it often tends not to work that way when you look at where the assets are in the funds.

Fund investors actually do a good job of picking active funds. … This is not only not realized, actually people make an argument against that, but that's not so. People don't pick categories well. They market-time categories and move into hot markets. But within a category, they actually do a good job, a very good job, of picking funds. So, when you look at asset-weighted averages of categories of the active funds, in most cases actually they outperform indexes. I went through…

Benz: How about index funds? Do they outperform the asset-weighted returns of index funds?

Rekenthaler: If they can outperform the indexes, they'll outperform the index funds, as the index funds typically will trail the indexes a little bit due to their drag of expenses. But I went through this 81 categories that have been around for 10 years in our mutual fund universe, and on an asset-weighted basis, the active funds, in about 65 of the categories, the active funds actually outperformed the benchmark index for that category over the 10-year period.

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