Passive Vs Active Fund Management
“It is my contention that active management does not make sense theoretically and isn't justified empirically. Other than that, it's O.K. But it's easy to understand the allure, the seductive power of active management. After all, it's exciting, fun to dip and dart, pick stocks and time markets; to get paid high fees for this, and to do it all with someone else's money. Passive management, on the other hand, stands on solid theoretical grounds, has enormous empirical support, and works very well for investors.”
Rex Sinquefield's opening statement at the Schwab Institutional conference in San Francisco, October 12, 1995.
If "active" and "passive" management styles are defined in sensible ways, it must be the case that
(1) Before costs, the return on the average actively managed euro will equal the return on the average passively managed euro and
(2) After costs, the return on the average actively managed euro/dollar will be less than the return on the average passively managed euro/dollar.
These assertions will hold for any time period. Moreover, they depend only on the laws of addition, subtraction, multiplication and division. Nothing else is required.
Capital markets work and diversification between all of these asset classes increases return and reduces risk. Over the long run, markets reward investors with positive returns for taking risks and providing capital. If they did not, the capitalist system would have collapsed long ago. Nearly forty years of academic research has shown that traditional managers are unable to outperform the markets by anything more than would be expected by chance.
At GoldCore Wealth Management we estimate the risk of different combinations of asset classes and find the overall portfolio strategy that best suits your particular circumstances and risk tolerance. That plan can be implemented exactly by investing in those same asset classes via passive, asset class portfolios. A financial advisor forfeits all of these advantages if passive investing is abandoned.
For actively managed portfolios it is difficult to measure the future:
Risk levels or
To know how these relate to various asset classes because these portfolios will invariably experience radical shifts in their strategy.
Therefore it is almost impossible to engage in or to try and implement long range sound financial planning if the inputs are actively managed.
In short, asset class passive investing is consistent with what we know about how free and fair markets function. Active management is not. Asset class investing is supported by the results of scores of empirical studies of fifty years of professionally managed portfolios. Active management is not.
Finally, asset class investing allows reliable planning and implementation of portfolio strategies. It is demonstrably successful and the most prudent way to invest a client's money. Conceptually, there’s no reason to debate whether or not passive management beats active management. Passive must win.
Why?
Because if we take all stocks as a group or any aggregation of stocks, an index that holds all of these stocks at their market capitalisation weights, will precisely track their return. Therefore an index will produce a better return than the same group of stocks that are held in total by investors who incur management fees, trading costs, taxes, administrative fees, commissions and sales charges.
By simply seeking to match the market, while incurring far lower investment costs than most fund managers and active small investors, index funds ensure that they do better than the average result for investors. If a market is efficient and, thus, stocks are always fairly priced, ending up with market-beating returns is a matter of luck, not skill.