Crack open the most effective portfolios and you’ll find both passive and active investments – and strategies that contain elements of both.

Passive equity investments, which track an index such as the S&P 500, have earned their place through low fees and, for the past eight years, strong performance relative to active managers with similar benchmarks. Like most good investment ideas, this shift – rightly described by Vanguard founder John Bogle as a tsunami – is in danger of being taken to extremes. At an annual growth rate of about one percentage point, capital flows into index funds are driving up the valuation of large cap stocks, which already have the highest weightings in the indices. Stocks with low representation in the indexes are being overlooked, creating a latent potential to eventually outperform, net of active management fees.
Investors need to consider the relative merits of both passive and active strategies for each asset class, along with the associated transparency, volatility, and risk characteristics, and after-fee returns, to ensure allocation to the optimal vehicle and the right measure of diversification. See chart below for our current recommended allocations.
Municipal bond and credit exposures are, in our view, best managed by hands-on investment managers. There are no universally accepted municipal bond indices, and those that exist are often not easily replicated. In a similar vein, the more interesting credit strategies, such as consumer lending and floating rate bank loans, do not have indices to replicate. For these reasons, we believe that the advantages of individually customized municipal bond and credit portfolios outweigh the (marginally) lower costs of passive strategies in these asset classes.
Equity opportunities are more complex, and we manage passive, active and blended portfolios in this asset class. Investors with single stock concentrations or significant exposure to a particular sector through their other investments and business interests require an active approach to diversification, as do all investors looking for alpha, and we customize and manage our active core equity portfolio accordingly. We employ what we describe as enhanced passive strategies for both domestic equities and developed international markets. We use the term enhanced because, although the funds reference an index, they will adjust security weightings by basic fundamental factors other than simply market capitalization, such as dividends or value.
At the extreme end of active management are hedge funds, which have suffered as an asset class since the financial crisis. Too much capital – $3.2 trillion at the height in 2015 – was handed over to global hedge funds, and they have for the most part competed away their advantage. Attempts to outsmart the market using proprietary security selection or other investment calls, such as market timing or sector rotation, no longer justify their very high-fee, high-turnover structures.
We continue to evaluate intriguing hedge fund strategies but generally take an enhanced passive approach to the alternatives market by selecting funds that provide exposure to a basic investment strategy, such as risk arbitrage, but do not attempt to provide the equivalent of proprietary security selection and therefore can charge lower fees. For instance, the AQR Multi-Strategy Alternative Fund aims to replicate the nine basic hedge fund strategies without making proprietary judgments or charging excessive fees, or carrying costs. In other words, we are in effect taking a passive approach to most of our liquid alternative investments. This is an unconventional but, in our experience, very effective strategy for high net worth individual, foundation and endowment portfolios.
Even if they could invest passively in illiquid alternatives, investors wouldn’t want to. The private equity and private real estate markets are far less efficient than the public markets and therefore provide real opportunity for active managers. Investing with a top-quartile manager is imperative. While past performance is no guarantee of future results, there is strong evidence that past superior investment performance in illiquid markets is persistent. We therefore look to invest through managers with excellent long-term track records.
It is our experience that, for high net worth private investors, endowments and foundations, the most resilient portfolios are diversified across both asset classes and investment styles. While we anticipate retaining a substantial exposure to both passive and active strategies, we also expect to see more hybrid investments in the future.
John A chart
John Apruzzese is the Chief Investment Officer at Evercore Wealth Management. He can be contacted at

Evercore Wealth Management, LLC ("EWM") is an investment adviser registered with the U.S. Securities and Exchange Commission under the Investment Advisers Act of 1940. EWM prepared this material for informational purposes only and should not be viewed as advice or recommendations with respect to asset allocation or any particular investment. It is not our intention to state or imply in any manner that past results are an indication of future performance. Future results cannot be guaranteed and a loss of principal may occur. This material does not constitute financial, investment, accounting, tax or legal advice. It does not constitute an offer to buy or sell or a solicitation of any offer to buy or sell any security/instrument, or to participate in any trading strategy. The securities/instruments discussed in this material may not be suitable for all investors. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. Specific needs of a client must be reviewed and assessed before determining the proper investment objective and asset allocation which may be adjusted to market circumstances. EWM may make investment decisions for its clients that are different from or inconsistent with the analysis in this report. EWM clients may invest in categories of securities or other instruments not covered in this report. Descriptions provided in this material are not substitutes for disclosure in offering documents for particular investment products. Any specific holdings discussed do not represent all of the securities purchased, sold or recommended by EWM, and the reader should not assume that investments in the companies identified and discussed were or will be profitable. Upon request, we will furnish a list of all securities recommended to clients during the past year. Performance results for individual accounts may vary due to the timing of investments, additions/withdrawals, length of relationship, and size of positions, among other reasons. Prospective investors should perform their own investigation and evaluation of investment options, should ask EWM for additional information if needed, and should consult their own attorney and other advisors. Indices are unmanaged and do not reflect fees or transaction expenses. You cannot invest directly in an index. References to benchmarks or indices are provided for information only. The securities discussed herein were holdings during the quarter. They will not always be the highest performing securities in the portfolio, but rather will have some characteristic of significance relevant to the article (e.g., reported news or event, a new contract, acquisition/divestiture, financing/refinancing, revenue or earnings, changes to management, change in relative valuation, plant strike, product recall, court ruling). EWM obtained this information from multiple sources believed to be reliable as of the date of publication; EWM, however, makes no representations as to the accuracy or completeness of such third party information. Unless otherwise noted, any recommendations, opinions and analysis herein reflect our judgment at the date of this report and are subject to change. EWM has no obligation to update, modify or amend this information or to otherwise notify a reader thereof in the event that any such information becomes outdated, inaccurate, or incomplete. EWM’s Privacy Policy is available upon request. EWM is compensated for the investment advisory services it provides, generally based on a percentage of assets under management. In addition to the investment management fees charged, clients may be responsible for additional expenses, such as brokerage fees, custody fees, and fees and expenses charged by third-party mutual funds, pooled investment vehicles, and third-party managers that may be recommended to clients. A complete description of EWM’s advisory fees is available in Part 2A of EWM’s Form ADV. Trust services are provided by Evercore Trust Company, N.A., a national trust bank regulated by the Office of the Comptroller of the Currency and/or Evercore Trust Company of Delaware, a limited purpose trust company regulated by the Delaware State Bank Commissioner, both affiliates of EWM. Custody services are provided by Evercore Trust Company, N.A. The use of any word or phrase contained herein that could be considered superlative is not intended to imply that EWM is the only firm capable of providing adequate advisory services. This material does not purport to be a complete description of our investment services. This document is prepared for the use of EWM clients and prospective clients and may not be redistributed, retransmitted or disclosed, in whole or in part, or in any form or manner, without the express written consent of EWM. Any unauthorized use or disclosure is prohibited. The Chartered Financial Analyst and CFA trademarks are the property of CFA Institute. Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, Certified Financial Planner™ and CFP® in the U.S.

IRS Circular 230 Disclosure:

Pursuant to IRS Regulations, we inform you that any U.S. Federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for (i) the purpose of avoiding IRS imposed penalties or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein. This information is provided for information purposes only and does not constitute financial, investment, tax or legal advice.

©2016 Evercore Wealth Management LLC. All rights reserved.