For all the losses on Treasuries this year, demand for U.S. government debt remains stronger than before the financial crisis. Investors bid for $5.75 trillion of notes in government auctions in 2013, or 2.87 times the amount sold, data compiled by Bloomberg show. That’s the fourth-highest ratio since the Treasury Department began releasing the data in 1993, surpassed only in the past three years as demand peaked at 3.15 times in 2012. Before the Federal Reserve began its unprecedented stimulus in 2008, the bid-to-cover ratio never topped 2.65. While Treasuries are poised for the first drop since 2009 as the longest-term bonds suffer the world’s deepest declines, the willingness of foreign central banks, insurers and pensions to finance the largest debtor nation may temper a further jump in U.S. borrowing costs. Yields on the 10-year notes rose last week to the highest since 2011 and forecasts imply the Fed will cut its Treasury purchases by more than 50 percent from $540 billion this year after beginning to taper earlier this month…Bids for interest-bearing Treasuries outstripped the $2 trillion sold competitively this year by $3.75 trillion, data compiled by Bloomberg show. The bid-to-cover ratio was almost 20 percent greater than the average 2.44 times from 1997 to 2007.

One of the primary decisions investors and their advisors are faced with in the portfolio construction process is the type of investment approach – active or passive – to employ. Is there value to be added in hiring active managers, or should a portfolio be passively constructed in order to simply gain the desired market exposures in a cost-efficient manner? Or perhaps a superior outcome can be achieved through a “core/satellite” approach, in which the components of the allocation representing the more efficient market segments are passively invested while active managers are selected for the satellite exposures where inefficiencies may be more prevalent. If so, which asset classes might best be designated as “passive” and which ones “active”? To add complexity, if a decision is made to employ some element of active management, the investor and advisor must then select specific managers to comprise those allocations.

Over the years, there has been a significant amount of research conducted on the active vs. passive question. The debate has generally boiled down to being a referendum on the merits of the efficient market theory (EMT), which posits that since market prices instantaneously react to the knowledge and expectations of all investors, it is impossible to systematically outperform the benchmark consistently. Adherents of EMT typically favor passive management and employ ETFs, index funds and other passive strategies in the portfolio construction process. On the other side of the debate are those that point to the long-term success of certain active managers such as Warren Buffett, Peter Lynch and John Templeton as evidence that markets are not efficient and that active management can indeed add value.

Conclusions from the results of a recent study on this topic: (1) certain Morningstar categories exhibit incidence of manager skill over time, and are therefore candidates for active management; (2) the alphas of the skilled group of managers are not only statistically, but also economically significant; (3) the incidence of manager skill is different for foreign and domestic equities across various economic environments; and (4) in terms of manager selection within categories designated as active, the best dimensions that predict future manager performance are the previous period’s active return, expense ratio and capture ratio.

Overall, our results tend to support the core/satellite approach to portfolio construction. The core (more efficient) categories such as those within the domestic large cap equity segment warrant passive allocation, while the satellite (less efficient) categories such as domestic small cap and international developed and emerging markets are good candidates for active management.