THE ADVANTAGES of ACTIVE MANAGEMENT While the Discussion May Start with Performance, It Should End with Meeting Your Investment Needs

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THE ADVANTAGES OF ACTIVE MANAGEMENT While the discussion may start with performance, it should end with meeting your investment needs.

The debate over active versus passive growth strategies – including passive ones Advantage 2: The Opportunity for (or indexed) market strategies is not linked to the NASDAQ Index. In the year Outperformance only unending, it tends to invoke 2000 aggressive investors took tremendous Investors in indexed stock funds and ETFs passionate responses. This can lead to hits during the tech bust, even as many expect results to be close to the index the impression that passive and active managers focused on fundamentals their manager mirrors minus expenses. investing are somehow at odds. The fact produced solid positive returns. In a more One of the arguments for indexing is that is, understanding the advantages and recent example, during the financial the stock market is a no sum game – for disadvantages of all investment choices crisis in 2008 and early 2009 many stock every buyer there is a seller. As a result is the best way to achieve a balanced, investors lost heart, sold stocks and stock the aggregate return of all investors sensible and investor-appropriate asset funds near the bottom, and missed out on will equal the market’s return, minus allocation. At Madison, we practice a the rapid recovery that followed. trading and operational expenses. While disciplined active management some managers may have the skill strategy which we believe can add to outperform their unmanaged value over time. We believe it is benchmarks, the argument goes, it particularly appropriate for investors is difficult to identify these managers who want to participate in up markets, who do so consistently, so why not but prefer a manager who has a simply go for the lowest expense history of showing relative strength in option? down markets. One of the first things to consider is Advantage 1: Risk Management whether the benchmarks or indices are and Maintenance of Asset worthy of emulation. Passive strategies Allocation that mimic popular indices have to, The long-term returns of any by their very nature, take on whatever investment strategy are contingent shortcomings the index contains. As on one important factor: the investor we saw in the tech boom, market cap- remain invested in the strategy for weighted indices which give the largest, the period in which performance most highly valued companies the is being assessed. Whether the biggest impact (such as the S&P 500) approach is indexed or active, real can become very much “followers of An active manager with a history of returns will vary tremendously if investors the herd,” when they hold large allocations trade in and out of the market or switch mitigating losses in downturns may in popular, but overpriced and speculative managers in response to short-term promote investment discipline and the securities. Indices also have an active market trends. We’ve seen this happen maintenance of an appropriate asset management component, as companies over and over during our investment lives, allocation. The ability to keep investors on are added and subtracted, often at times and the results can be punishing. The most course may turn out to be a much more that are not ideal, as when a company is pronounced example was the flood of important factor in their real returns than held until bankruptcy. investment dollars during the tech boom whether a given manager or investment that left conservative, actively managed vehicle was a percent above or below an At Madison, our core stock investment equity strategies and went into aggressive index over a particular period. strategy is to find companies with

madisonfunds.com | 888.971.7135 550 Science Drive | Madison WI 53713 outstanding business models, of the tenets of the science of behavioral Conclusion management and fundamentals and economics. Selecting active managers is a In short, we are firm believers in the purchase these when the valuation is way for investors to find a match with their opportunity for outperformance and attractive. We believe this is the key risk profile, since historical results suggest believe active oversight of stock portfolios to solid, long-term risk-moderated the philosophy and discipline of a manager is an essential tool in engineering performance. On the bond side, it is our can be linked to the overall volatility and appropriate risk management. In bond experience that investors expect this risk of a mutual fund. portfolios we believe most investors favor part of their asset allocation to provide risk moderation. Although we prefer active Advantage 4: The Special Issues stability and help with capital preservation. management, we would never argue with Passive Fixed Income Our active bond management allows us that indexing is universally inappropriate. Strategies the flexibility to shorten bond maturities The pairing of passive and active stock While you can’t invest directly in an index, when interest rates appear likely to rise. strategies strikes us a sensible approach an investor whose main objective is to Since bonds typically lose value in rising for many investors. We are less impressed match an index’s performance will be rate environments, and longer bonds are with the results of passive investing in drawn to a passive strategy linked to the more susceptible to this effect, shortening bonds, where dispersion from the index is index of choice. This works remarkably portfolio maturities has the potential to a serious hindrance to achieving desired well in the world of stocks. Managers of mitigate losses. We believe these stock results. and bond strategies give us the best passive stock products have shown the opportunity to provide superior risk- ability to consistently produce results close moderated returns. to the index of choice. It’s our observation this is much less true in the bond world, The returns of all indices and Morningstar Advantage 3: Finding the Best where passive strategies have shown categories are used for illustrative Match considerable variance from their index. purposes only and do not reflect the performance of any Madison portfolio or While investors may be pleased to see This could be a major disappointment to product. their equity portfolios rise in tandem with investors whose expectations may not be the market, they may be less pleased to matched by their passive bond fund or capture all of the market’s downsides, as bond ETF. we saw in 2008. This aversion to loss is one

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