Active versus Passive Management of International Mutual Funds ...

fundamental indices resembled an active strategy, as fundamental indices cannot be held in
equilibrium by every investor. Fundamental indexing requires a rebalancing at some time period
and subjective choices must be made as to the construction of the index. These choices may
include book value, sales, earnings, dividends, etc. [12].
Cai and Houge [22] added support to active management fundamentals as they illustrated
the impact of rebalancing the portfolio. They examined the annual additions and deletions of the
Russell 2000 from mid 1979 through 2004. They found that a buy-and-hold strategy
outperformed an annually rebalanced Russell 2000 by an average of 2.22 percent during the 1st
year and by 17.29 percent for up to 5 years after reconstitution. These results suggested that
index construction methodology may provide an incentive for portfolio managers to deviate from
their benchmark styles [22].
Arugaslan, Edwards, and Samant [8] conducted a study that evaluated the performance of
50 large U.S. based international equity funds for the period from 1994 to 2003 for a five-year
and ten-year performance period. Their study utilized data from the Morningstar (2004) edition
and compared returns to the Morgan Stanley Capital International Index Europe, Australia, and
Far East Index and the S&P 500 index. Their study utilized quarterly data and calculated the
Sharpe, Treynor, and Jensen measures. They then used the Modigliani and Miller M squared
measure to evaluate the performance of the international funds to the benchmark indices. Their
study found that once risk was included in the analysis of the highest performing funds investors
may find them less attractive [8].
Li [60], in one of the most recent studies regarding active versus passive management,
found that a combination approach may be the better solution toward portfolio management. Li’s
study analyzed the period from 1994 through 2008 using the data from the Morningstar database.
By calculating Jensen’s Alpha, Li makes mutual fund allocation recommendations by investment
categories [60].
Bogle and Sullivan [15] reaffirmed the debate between active and passive investing.
Bogle noted that the risks are dominated by money and vested interests as the view of Congress
and the administration is short term. The changes will continue, because individuals own only
24% of all stocks. The index fund is a good innovation, as investors will do better by simply
owning the market at a low cost rather than owning the market at a high cost. If investors truly
believe that the value of U.S. companies had not dropped by $9 trillion dollars in the last year,
then there is value in owning the index [15]. By inference, one would have to believe noise has
been created through the incorrect pricing of the securities and opportunities exist for
fundamental indexing whether one believes it is passive or active.
Summary
The literature review has presented a chronological review of the evolution of the theory,
thought, and status of the active versus passive management debate. The information presented
started with the development of MPT and concluded with current thoughts of future investment
within the global market.
Bogle and Sullivan [15] identified the continued need for research in the passive versus
active management debate. Their inference of potential mispricing of the market securities due to
the recession, pose an excellent foundation for either side to profess the value of their strategy.
Lehmann and Modest [59] illustrated the fact that a suitable benchmark was needed to
measure the performance of actively and passively managed funds. To this end, researchers have
used the S&P 500 index as the appropriate index to benchmark returns when comparing the two
management styles. Since then researchers have incorporated various indices, such as the Russell
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