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Debating Active Managers vs. Index Funds

The active vs. passive debate may be one of the biggest in the investing world, but in the minds of investors themselves, the active funds still appear to hold sway.

With markets soaring in the 1990s, many investors discovered index mutual funds, or "passive" funds, which track benchmarks.

Index enthusiasts figured that they could mechanically buy S&P 500 funds and hold them for the long term. Some analysts predicted that investors would eventually stampede to index funds and abandon actively managed portfolios -- which employ managers who attempt to top the benchmarks.

But lately, actively managed funds have enjoyed enormous growth. In 2007, American Funds, an active manager, had inflows of $74 billion, according to Financial Research Corporation. Other active fund groups that recorded more than $10 billion in inflows included Dodge & Cox, Franklin Templeton and T. Rowe Price.

Of the $12 trillion held in mutual funds, about 90% is in actively managed funds, says Avi Nachmany, research director of fund tracker Strategic Insight. The market share of index funds has remained static in recent years, and it is not likely to grow in the future, says Nachmany.

"Many retail investors are anxious about investing in stocks, and they feel more comfortable when a professional manager watches the assets in an active fund," says Nachmany.

To be sure, exchange-traded funds, which track benchmarks, have been growing. But the ETFs account for only $600 billion in assets. So active mutual funds still control the market, dominating retirement plans and growing relentlessly.

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