Will Trump help active management recover its mojo?
- Robin Powell
- 2 minutes ago
- 5 min read
Donald Trump’s return to the White House has investors on edge — but does more uncertainty mean it’s time to abandon passive funds in favour of active management?
Whether you like Donald Trump or not, no one can say the start of his second stint as President has been dull. Almost every day, he says something we weren’t expecting, whether it’s threatening to trigger a global trade war, annexe Canada or fire the chair of the Federal Reserve.
From a financial markets perspective, whether he actually follows through on any of these things is not the point. His words alone create uncertainty — something markets notoriously struggle with.
Ironically, investors seemed hopeful until recently that Trump’s return to the White House would be good for stock prices. It now looks likely, at best, that investors need to brace themselves for regular bouts of volatility over the next four years. At worst, a protracted bear market could be looming, particularly if a trade war sparks a global recession.
What does Trump 2.0 mean for investors?
What, then, does Trump’s return to the Oval Office mean for investors? At the time of writing, most markets outside the US are hovering around the level they were at before the President’s “Liberation Day” announcement on 2nd April. But US stocks, which still account for well over half the world’s stock market capitalisation, are still deep in correction territory.
By reducing your US exposure now, you would only be crystallising what, at this stage, are still just paper losses. As Abraham Okusanya, Alex Crowther and Laurentius van den Worm have already explained, history shows us, time and again, that diversified investors who ride out short-term volatility have generally been rewarded in the past.
But based on the first 100 days of Trump’s second term, are investors better off in passive or other systematic, funds, or in funds run by traditional active managers?
Of course, fund providers keep telling us that active stockpicking and market timing come into their own in times of uncertainty and in bear markets. But is it actually true?
Do active managers perform better in volatile markets?
In theory, periods of market volatility provide a favourable environment for active managers. After all, it’s at such times that mispricings are more likely.
However, in their 2001 paper, Mutual Fund Performance in Extreme Market Conditions, Elton, Gruber and Blake found that only a small subset of managers outperform during periods of high uncertainty. Ferreira et al. came to a similar conclusion in their 2012 paper, Does Active Management Pay During Periods of High Market Stress?
Other studies provide slightly more encouragement. A 2015 study, Are Mutual Funds Active During Crisis Periods?, by Getmansky, Lo and Wang, found that some active fund managers do succeed in reducing losses in a crisis by moving out equities and into safer assets such as cash. But, the authors said, those who do so are in a small minority.
In their 2020 paper Uncertainty and Mutual Fund Performance: The Role of Investor Sentiment, Pelizzon et al. concluded that some managers who have demonstrated strong skill in the past manage to reproduce that success in times of volatility. But, they found, the majority of active funds underperform the index in a crisis.
Can active funds protect you in a downturn?
In short the case for switching to active management in expectation of regular volatility between now and the next Presidential Election seems flimsy at best. But what if the US, or indeed the world, is about to enter a recession? What if we can no longer rely on what Warren Buffett has called the “great American tailwind” to keep driving global stock markets?
Again, the evidence suggests that switching to active funds is unlikely to improve your returns. A 2020 paper by Russ Wermers found that although the average mutual fund does add value before expenses through stock selection during a bear market, net returns are negative after expenses. Crucially, Wermers found very little evidence that active managers are able to time the market successfully.
So what happened in the last major bear market, the severe downturn that occurred in March and April 2020 as the scale of the Covid-19 pandemic became clear? In a 2021 paper, Clare, Motson and Thomas found that very few funds outperformed, and those that did were typically sector-specific or had a defensive tilt. Most active funds failed to protect investors’ capital better than their passive peers.
The most recent analysis of active fund performance in bear markets was conducted by Anu Ganti at S&P Dow Jones Indices. Ganti looked at the 24-year history of the SPIVA US scorecard. Over the period, the S&P 500 produced negative annual returns five times. In all five of those years, most large-cap equity funds lagged the index.
Ganti then compared the performance of active managers in years when markets declined relative to their performance in years when markets rose.
An average of 56% of stocks outperformed the S&P 500 during the five years when the index declined — higher than the 46% that did so during the 19 years of market gains. This outcome is intuitive, as falling markets tend to set a lower bar for outperformance. Yet even in these more favourable conditions, 61% of large-cap funds still lagged the index, which is only slightly better than the 65% underperformance rate during up years and the 64% average over the entire 24-year period.
Index funds remain the logical choice
These studies make one thing clear: active management may offer the possibility of beating the market, but not the probability. You might just happen to pick a fund that outperforms during the rest of Trump’s second term — but the odds are firmly against it.
And even if you do back a winner, then what? Stick with them and hope their style suits the next administration too? Or jump ship again and try to second-guess the next political cycle?
History shows how hard it is to make those calls. If you can’t predict the future — and who can? — your best bet is to stay the course with index funds.
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