Tuesday, April 22, 2008

Its time to get "active" about being "passive"!

OK, so a money manager tells you that he can beat the benchmarks on a regular basis. You check the facts and low and behold.....not true! Most fund managers cannot beat the index with any more predictability than I can predict the flip of a coin; well actually they are not nearly that good! I can probably predict the coin 50% of the time while recent stats suggest about 85% of fund managers did not make the benchmark over the last 3 years .

When a manager buys and sells securities in an attempt to beat the benchmark, that is called active management. If the same manager bought the index fund and held onto the index for the year, then we would say they did not try to beat the benchmark and are a "passive" manager.
Now, as guys/gals we know that "passive" is not generally a positive trait in people....we think of passive as being, well, wimpy! We want to be considered "active" which certainly sounds healthy and positive and a much better verb than passive.
To those who love "active"management it is as simple as the lottery philosophy; you can't win if your not in the game! Passive will never beat the benchmark! It will just outperform active funds about, oh say, 85% of the time! And did I mention it costs a lot less to own the passive index?
So for some time the debate has raged about "passive vs active"! But, of course life is not that simple! Money managers. realizing the inherent value in diversified low cost indexes, started to use them in an "active" fashion. Now the "passive" product is being actively managed to beat the indexes that they track! Huh? Well, actually, it does make sense if you can forecast which indexes are going to go up or down the most, and switch out of the dropping index and into the rising index! Of course, if you can't then it is a bunch of active trading that fails to beat the benchmark just like the active stockpicking did.
So how do we label our money managers?

1- active/active manager> actively manages stocks which are an active security
2- active/passive managers> actively manages indexes which are a passive security
3- passive/passive> buys and holds index funds with periodic rebalancing
4- buy and hold> buys stocks which are active securities but is passive in managing them

So there are a lot of ways to manage money and you need to know which your advisor is focused upon! I therefore highly recommend you get "active" about how your money is managed, don't be 'passive" about the results, and when it comes to fees, actively pursuing passive products will generally reduce your fees!
....time for a rest, I've had an active day!


Anonymous said...

Mike - I like your style but you have to be missing something. I heard there were about 50,000 professionals out there selling funds and charging fees. Are you saying that most of them are below average.And how can you know if your guy is one of the good ones?

Average guy

sois mike said...

Well, Av, I wish I was missing something! I don't make up the studies and even the fund guys don't argue that most active managers do not beat the indexes. Why else would they brag so much when they actually do manage to beat the passive index.....shouldn't it be like scoring an open net goal when you beat the index that has nobody managing it?

I offer the following quote taken from Bogle's book on investing:
(Yeah, the Vanguard guy).

JACK R MYERS, Harvard Management Company, 2004 Business Week interview
“The investment business is a giant scam” “I will say 85-90% of managers fail to meet their benchmarks…”
There are a lot of other quotes from a lot of bright money managers and the message is consistent! If you want to find a good advisor you need to have a great investment policy statement upfront, and hold the manager to it!
If fees are over 1.5% keep looking or do it yourself!
p.s. There are companies that do prescreening of advisors, including the one I work for (I say sheepishly).