Posted By 
By Noah Solomon,
Special to Financial Independence Hub
There’s something happening here
What it is ain’t exactly clear
I think it’s time we stop
Children, what’s that sound?
Everybody look what’s going down
- For What It’s Worth, by Buffalo Springfield
Over the past two decades, the asset management industry has witnessed a massive transformation during which assets have migrated from active to passive approaches.
Notwithstanding the obvious appeal of passive investing, I believe that most of the debate between active vs. passive management misses some critical points. This month, I discuss why active vs. passive is not an either/or proposition and how the two approaches are not mutually exclusive. I will also discuss what I refer to as the three pillars of active management: the characteristics that determine whether an active manager can add value to investors’ portfolios.
The Trend is your Friend …. Until the End when it Bends
In 16 of the past 35 years, the majority of active large-cap U.S. managers outperformed their benchmark. However, there have been environments when active managers clearly dominated passive portfolios, such as the period from 2000 to 2009, when more than 50% of active large-cap U.S. managers outperformed the index in nine out of ten years.
Passive investing is not a panacea. Capitalization-weighted indexes are price momentum-based strategies that are forced buyers of overpriced assets during bubble scenarios. As a result, they tend to do well in rising markets dominated by a few sectors or individual securities. However, this concentration can be very costly during market downturns. There is no built-in buffer or margin of safety and no risk management: just full participation, up or down.
By contrast, active managers are often constrained by individual stock and sector weighting constraints and/or valuation discipline. It is not coincidental that the majority of active managers outperformed during the post tech-bubble bear market of the early 2000s when unreasonably valued technology stocks which were heavily weighted in indexes suffered severe price declines.
Pillar #1: Dare to be Different
Many so-called active funds closely mirror their benchmark indices. These “closet indexers” offer no real value. The math is cruelly straightforward: if an active manager holds a portfolio that is not materially different from their benchmark, then their performance will approximate that of the index less fees (near-guaranteed underperformance). Moreover, such portfolios are almost perfectly correlated to their benchmarks, which renders them utterly incapable of providing diversification vs. benchmark indexes. and providing downside protection in bear markets.
Academic studies have shown that funds which differ materially from their benchmark indexes were more likely to outperform. Make no mistake: holding a portfolio that differs materially from the benchmark doesn’t guarantee outperformance, but it shows that at least you’re trying!
The issue of closet indexing has been particularly pervasive in Canada. A 2013 paper titled “The Mutual Fund Industry Worldwide: Explicit and Closet Indexing, Fees, and Performance” analyzed the prevalence of closet indexing in different countries. Out of the 20 countries which the study analyzed, Canada ranked highest in terms of the percentage of its actively managed funds that were not truly active, with over 40% identified as closet indexers. This is not surprising given the relatively small size of the Canadian markets and the associated scarcity of highly liquid stocks. Once a fund gets to a certain size, it has little choice but to hug the index unless the manager is willing to sacrifice liquidity and flexibility.
Pillar #2: Downside Protection
From a long-term investing perspective, avoiding losses is more powerful than capturing every last basis point of upside. It takes a 43% gain to recover from a 30% loss. In the past 25 years, the S&P 500 has fallen 30% or more three times. Preserving capital in such environments makes it easier to recover and better compound wealth over the long term. All outperformance is not created equal: outperformance in bear markets is of greater value than outperformance in bull markets. Active managers who can preserve capital in bear markets offer significant value for their clients.
Pillar #3: Consistency
Assessing a manager’s performance across a full market cycle is imperative for understanding the advantage of their approach and their ability to navigate challenging markets. Consistency is essential: a manager who almost always lands in the top half of their peer group offers better long-term results than one who places in the top quintile in one year and falls to the bottom the next. Importantly, managers who consistently protect on the downside are better positioned to deliver outperformance over the long term.
However, history shows that the ability to preserve capital in declining markets is difficult to do on a consistent basis. There has been little persistence among active managers in terms of their ability to preserve capital in challenging environments. During the dotcom crash, 52% of U.S. active managers outperformed, but just 44% of them did so during the global financial crisis. Moreover, only a quarter of the active managers who outperformed during the dotcom bust did so during the next bear market.
Where Differentiation meets Consistency
At Outcome, we are not shy about deviating from benchmarks: a stock or sector’s weighting in the index plays no part in our portfolio construction. This differentiation, along with our algorithmic approach to investing, has added considerable value for our clients.
Since its inception nearly eight years ago, the Outcome Canadian Equity Income Fund has outperformed its benchmark by 9.4%. By contrast, 90% of Canadian dividend-focused managers have underperformed, according to data from S&P Global. Importantly, the fund has outperformed while exhibiting less volatility and suffering shallower losses in challenging environments.
Our ability to preserve capital in declining markets has been consistent across market declines, including the fourth quarter of 2018 (-4.9% vs. -8.4% for the benchmark), the Covid Crash of early 2020 (-18.9% vs. -29.9% for the benchmark), calendar 2022 (+2.5% vs. -4.3% for the benchmark), and more recently, March of this year (+0.7% vs. -1.8% for the benchmark).
Given the success of our approach to Canadian equities, we launched the Outcome International Equity Income strategy at the start of the year. The new mandate is based on the same principles and technology as its Canadian predecessor, and we look forward to delivering similarly meaningful results for our clients.
Noah Solomon is Chief Investment Officer for Outcome Metric Asset Management Limited Partnership. From 2008 to 2016, Noah was CEO and CIO of GenFund Management Inc. (formerly Genuity Fund Management), where he designed and managed data-driven, statistically-based equity funds.
Between 2002 and 2008, Noah was a proprietary trader in the equities division of Goldman Sachs, where he deployed the firm’s capital in several quantitatively-driven investment strategies. Prior to joining Goldman, Noah worked at Citibank and Lehman Brothers. Noah holds an MBA from the Wharton School of Business at the University of Pennsylvania, where he graduated as a Palmer Scholar (top 5% of graduating class). He also holds a BA from McGill University (magna cum laude).
Noah is frequently featured in the media including a regular column in the Financial Post and appearances on BNN. This blog originally appeared in the July 2026 Outcome newsletter and is republished on Findependence Hub with permission.
