October 2016

The Wall Street Journal has been publishing articles about passive investing recently.  Many of these articles look like they are pro-passive, but are written by active management shops looking to damn passive with faint praise.  My last post addressed the ‘settle for average returns’ fallacy.  The second argument I often see in support of active management is that it outperforms in down markets. I’m not sold on the data behind this assertion, but let’s assume it’s true and active managers outperform during down markets.  Maybe they aren’t completely invested and hold cash or maybe they just pick the stocks that don’t go down as much.  Whatever the secret, CONGRATULATIONS!  YOU BEAT THE MARKET DURING DOWNTURNS!!! Now you just need to know when the next downturn starts and ends so you can go active at the right time.  That’s where the argument starts to break down.  It’s difficult/impossible to predict what…

With the recent flood of Wall Street Journal articles about passive investing, now is a good time to review the space.  Money is pouring into firms like Vanguard and iShares, the leaders in the indexing revolution.  Investors are seeing that despite perennial declarations of a “stock-picker’s market”, active managers consistently trail their benchmarks and charge large fees for the privilege of doing so.   You’ll see below that I am an advocate of passive investing, but only when it’s done correctly.  There are plenty of opportunities to use passive incorrectly or to get ripped off by a non-fiduciary product seller. What is passive?  A passive investment is just a rules-based strategy.  Technically, there should be a corresponding index.  For example, if the rule is to weight the investment based on the number of vowels in the company’s name, there should be a high-vowel index that the strategy would use as a…