Passive vs. Active Portfolio Management

Choosing whether an active or passive strategy is right for your portfolio is an important and challenging decision and the answer may depend in the areas of the market in which you are investing. In more “efficient” markets, passive is traditionally preferred, but it is believed that active managers are able to outperform in areas like international-small cap stocks.
Morningstar recently took a look at all the mutual funds from its international small/mid-cap categories and found that these categories have many underperforming funds. In a review of Morningstar’s international small-cap growth, value and blend categories, analysts concluded investors would have less than a 50% chance of picking an outperforming fund. As Abby Woodham pointed out in her 6/20/14 article Passive vs. Active: Debating International Small Caps, “The average results are mediocre, but when we look at the list of funds that receive a Morningstar Analyst Rating, actively managed funds begin to look more attractive.”
While the funds on her list have provided significant alpha recently, they can be relatively expensive and their outperformance may waiver. And that leads to the challenge: even if active funds add value, they may not be consistent over time and, if you fail to catch them when this happens, your returns will lag passive funds. If you are concerned that the outperformance will not continue, but you want international small-cap value, an alternative may be a passively managed ETF.