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What opportunistic approach may work best for implementing active and passive strategies?

While there is little disagreement that equities are a cornerstone of most investment portfolios, fierce controversy continues over how best to gain exposure to the asset class. Many have argued for the superiority of either actively or passively managed equities, usually preferring one over the other as structurally better and deserving of a full allocation.

Morgan Stanley’s Global Investment Committee challenges this traditional framing. This essay explains why the better choice varies with market conditions and is often a measured combination of the two approaches. We believe that acting on the opportunity presented by the current economic circumstances, combined with making use of the latest thinking about the selection of investment managers, can provide performance benefits.

Here, we develop a systematic means of translating historical observations into what we believe are optimal allocations of active and passive equity investments across market cap and style. As a first step, we looked to the market and identified signals that give indications of how the current environment promotes success for active managers.

To gain entry into our model, these signals must have proven to be effective in predicting periods of active manager out-performance, as well as be in accord with economic intuition. Using this standard, we isolate nine measures that, in combination, guide the recommendations of the current outlook to assess the relative attractiveness of active and passive management.

To allocate between active and passive, we first couple our model-driven view of the current environment with the long-term performance of active strategies across styles. Synthesizing the two provides an allocation: We recommend being fully active when the environment is most attractive, fully passive when least attractive and more balanced when moderate.

Based on our analysis, both active and passive strategies have shown strong performance when their respective attractive conditions exist.

Finally, selecting a portion of a portfolio to be actively managed is only part of our recommendation. Manager selection is also vital for performance, and we have developed cutting-edge methodologies to identify managers with the potential to outperform across environments. Combining optimal active and passive allocations with managers possessing high convictions may deliver our best implementation for equity portfolios.

The KPK Group is an advisory team with the Wealth Management division of Morgan Stanley in New York, N.Y. The views expressed herein are those of the author and may not necessarily reflect the views of Morgan Stanley Smith Barney LLC, Member SIPC, www.sipc.org. Morgan Stanley Financial Advisors engage Worth to feature this article. Advisors may only transact business in states where they are registered or excluded or exempted from registration (www.morganstanleyfa.com/kpkgroup). Transacting business, follow-up and individualized responses involving either effecting or attempting to effect transactions in securities, or the rendering of personalized investment advice for compensation, will not be made to persons in states where they are not registered or excluded or exempt from registration. The strategies and/or investments referenced may not be suitable for all investors. Morgan Stanley Private Wealth Management, a division of Morgan Stanley Smith Barney LLC. Member SIPC. CRC1311349 11/15

This article was originally published in the December/January 2016 issue of Worth.

While there is little disagreement that equities are a cornerstone of most investment portfolios, fierce controversy continues over how best to gain exposure to the asset class. Many have argued for the superiority of either actively or passively managed equities, usually preferring one over the other as structurally better and deserving of a full allocation.

Morgan Stanley’s Global Investment Committee challenges this traditional framing. This essay explains why the better choice varies with market conditions and is often a measured combination of the two approaches. We believe that acting on the opportunity presented by the current economic circumstances, combined with making use of the latest thinking about the selection of investment managers, can provide performance benefits.

Here, we develop a systematic means of translating historical observations into what we believe are optimal allocations of active and passive equity investments across market cap and style. As a first step, we looked to the market and identified signals that give indications of how the current environment promotes success for active managers.

To gain entry into our model, these signals must have proven to be effective in predicting periods of active manager out-performance, as well as be in accord with economic intuition. Using this standard, we isolate nine measures that, in combination, guide the recommendations of the current outlook to assess the relative attractiveness of active and passive management.

To allocate between active and passive, we first couple our model-driven view of the current environment with the long-term performance of active strategies across styles. Synthesizing the two provides an allocation: We recommend being fully active when the environment is most attractive, fully passive when least attractive and more balanced when moderate.

Based on our analysis, both active and passive strategies have shown strong performance when their respective attractive conditions exist.

Finally, selecting a portion of a portfolio to be actively managed is only part of our recommendation. Manager selection is also vital for performance, and we have developed cutting-edge methodologies to identify managers with the potential to outperform across environments. Combining optimal active and passive allocations with managers possessing high convictions may deliver our best implementation for equity portfolios.

The KPK Group is an advisory team with the Wealth Management division of Morgan Stanley in New York, N.Y. The views expressed herein are those of the author and may not necessarily reflect the views of Morgan Stanley Smith Barney LLC, Member SIPC, www.sipc.org. Morgan Stanley Financial Advisors engage Worth to feature this article. Advisors may only transact business in states where they are registered or excluded or exempted from registration (www.morganstanleyfa.com/kpkgroup). Transacting business, follow-up and individualized responses involving either effecting or attempting to effect transactions in securities, or the rendering of personalized investment advice for compensation, will not be made to persons in states where they are not registered or excluded or exempt from registration. The strategies and/or investments referenced may not be suitable for all investors. Morgan Stanley Private Wealth Management, a division of Morgan Stanley Smith Barney LLC. Member SIPC. CRC1311349 11/15

This article was originally published in the December/January 2016 issue of Worth.

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