For every buyer there is a seller. Mathematically, this implies that the full universe of asset managers can only achieve the average return of the market. Add in fees, and actively managed investment funds should theoretically consistently underperform passive investments.
However, the counter-argument is that there are some really good managers out there who generate significant outperformance on a consistent basis, even after fees. The challenge is to find yourself a ‘good’ manager.
HEADS OR TAILS?
Active managers, for instance, have the ability to switch into cash in troubled times, and to position their portfolios for specific economic and business cycles in the belief that markets are far from rational, due mostly to human biases and automated trading instructions. I would add, volatility has been exacerbated by day-trading as well as the proliferation of new investment instruments.
Then some argue there’s the perverse investment incentive of active managers to churn your hard-earned money for his commission. Various research has found that only about 10% of the variability in portfolio returns comes from manager skill, and even that is possibly more down to luck. The rest is ‘the market’.
Jim Cahn, a contributor to Forbes, said that: ‘If you believe that markets are efficient, that market prices have incorporated all information that could impact the price of a security, then you likely should be a passive index investor. Passive investing is a “buy and hold” strategy where money is invested in securities proportionally to their representation in a market capitalization weighted index.’ And billionaire Jeffrey Vinik, who once ran one of the world’s largest actively managed funds, told CNBC: ‘For most investors, a balanced portfolio makes the most sense. I would advise having half passive and half active in their portfolio.’
Reams of academic research, various presentations and media articles lead to one inescapable conclusion: there is no right or wrong answer. Maybe the key question should be what are you trying to achieve? Then what will work best for this?
Author: Mike Lledo CA(SA) is the CEO at Consolidated Financial Planning