Active and passive: A practical “how-to” for advisors

Key takeaways

• Diversification seeks to help manage risk, smooth portfolio outcomes, and improve the likelihood that clients stay invested and on track toward their long-term goals.
• We believe active management can add value when applied selectively in less efficient markets with greater dispersion, complexity, or limited transparency.
• A multi-manager approach can help manage risk and work to improve consistency by combining complementary strategies rather than relying on a single manager or style.

In a previous article, we explored why combining active and passive strategies can be an effective way to offering practical guidance on how advisors can design and implement a diversified active-passive portfolio that we believe may help increase the likelihood of clients staying on track toward their financial goals.

At Russell Investments, we believe success in active-passive portfolios is driven by three core principles:

• A goal-driven asset allocation process
• Targeted use of active management where it is most likely to add value
• Thoughtful implementation of both active and passive components

Regardless of whether exposures are implemented actively or passively, asset allocation should always begin with client goals. Every client brings a unique set of objectives, circumstances, and preferences, and those factors should anchor portfolio construction from the start.

While client situations vary widely, they typically fall into a few core dimensions:

• Financial objectives (growth, income, capital preservation)
• Time horizon (accumulation vs. retirement)
• Risk tolerance (conservative, moderate, aggressive)
• Liquidity needs (ability and willingness to accept illiquidity)

The objective is not to eliminate volatility, but to build portfolios that clients can stay committed to across full market cycles. Taking too little risk can be just as damaging as taking too much, particularly for investors with long-term goals. Striking the right balance is essential.

Diversification plays a central role in managing this balance. Russell Investments approaches diversification intentionally, beginning with a mix of asset classes designed to seek to improve the probability of achieving client outcomes.

A typical diversified Russell Investments portfolio includes:

• Global equities, spanning U.S., non-U.S., and emerging markets
• Fixed income, including both investment-grade and return-seeking sectors
• Real assets, such as real estate and infrastructure, offering growth, income, and inflation sensitivity

Each asset class is included with the goal of either enhancing return potential or improving diversification, helping to smooth the overall client experience.

Once the strategic asset allocation is set, the next step is determining where active management is most likely to be rewarded. While we believe active management can add value across many market segments, some areas offer more fertile ground than others.

Markets that tend to favor active management often exhibit one or more of the following characteristics:

• Greater dispersion of returns, increasing the payoff for skillful security selection
• Less analyst coverage or transparency, allowing insights to persist longer
• Evolving or less standardized market structures, making index construction more challenging

Based on these characteristics, Russell Investments’ active-passive portfolios typically emphasize active management in:

• Real assets (infrastructure and real estate)
• U.S. small-cap equities
• International equities, both developed and emerging
• Fixed income, including investment-grade and return-seeking segments

Segments that offer attractive active opportunities often come with higher dispersion of outcomes, and that makes implementation especially critical to success. To manage this risk, Russell Investments favors a multi-manager approach, rather than relying on a single manager to deliver excess returns.

For example, instead of selecting one manager for U.S. small-cap equity exposure, we combine multiple high-conviction strategies with complementary strengths. This approach is grounded in decades of manager research and due diligence, guided by emphasis on the four “P’s”:

• People – experienced, insightful decision-makers
• Process – well-resourced, repeatable investment processes
• Philosophy – clearly articulated and empirically supported
• Performance – results that align with stated process and risk exposures

Our focus is not on chasing past performance, but on understanding how returns are generated, assessing repeatability, and evaluating risk controls, so we can identify managers that we believe may be best positioned for future success.

Effective multi-manager portfolios also require thoughtful portfolio construction. We intentionally combine managers with:

• Different investment styles (growth, value, core)
• Different decision frameworks (fundamental and quantitative)
• Different risk exposures

The goal is to reduce reliance on any single manager, style, or market outcome—while improving consistency through time.

Ongoing oversight is the unifying final element. Active portfolio construction doesn’t stop at manager selection. That is just the beginning. Russell Investments’ portfolio managers are continually reviewing the portfolios for:

• Appropriate manager sizing
• Overlap and unintended risks
• Continuous evaluation of manager changes and new opportunities

This discipline can be particularly valuable in higher-risk segments, such as emerging markets or small-cap equities, where individual security and manager risk can be elevated, even when overall portfolio allocations are modest.

And finally, don’t overlook passive implementation.  While passive investing may appear straightforward, not all passive implementations are created equal. The goal of passive investing is not to outperform, but to reliably capture market returns.

That means emphasizing passive providers with:

• Strong operational capabilities
• Effective index-tracking processes
• Consistent execution

Choosing passive managers based on short-term outperformance can be counterproductive. A passive strategy that outperforms an index in one period can just as easily underperform in the next, creating outcomes clients don’t expect from their passive exposure.

Thoughtful implementation matters on both sides of the active-passive equation.

Active-passive portfolios can be a powerful way to manage client assets, but success requires more than simply choosing a split and assigning managers.

In our view, advisors and investors may benefit from:

• Goal-driven asset allocation
• Selective, research-based use of active management
• Intentional portfolio construction that integrates active and passive strategies

When implemented with care, an active-passive approach helps align portfolios with client goals while managing risk, costs, and expectations across market cycles.