The Institute for Innovation Development recently sat down with Bob Mann, CEO of Advisor’s Capital Investments in Woodstock, Conn., which provides a unique mix of services offering financial education, support and specialized money management services for institutions, high-net-worth investors and leading financial advisors. Bob is an expert on market cycles and a market technician with a very strong case for active money management over passive investing.
Hortz: Bob, you’ve been involved in this active versus passive debate for some time. You go back to 1978 with a study called “Non-Random Profits,” which was your answer to Burton Malkiel’s “A Random Walk Down Wall Street”—a book that argued professional investors and mutual fund managers did not outperform a random selection of stocks and helped spawn the development of index funds. The research in your study led to very different conclusions about active management. Can you share with us what your research findings were and where you now stand on the active versus passive debate?
Mann: Contrary to the random walk approach, which assumes that an investor can do just as well with a stock selected by chance as with stocks bought with extensive research or while trading with a trend, our study identified stock price patterns that would enable an investor to buy low and sell high with an extremely high degree of consistency provided he or she used some discipline. The non-random profit approach we developed gave the investor two basic rules to determine what stock to buy and what price to pay for it—the “11 quarter rule” and the “25% rule.”
The results of applying our approach to data stretching back to 1936 showed numerous stocks and industry groups poised for large gain. The method identified over 600 stocks, which on average gained more than 300% within approximately three years from their theoretical date of purchase. There were no losses; only eight issues rose less than 50%. History shows that they all rose in conformance to past data.
Over the last 40 years, this has continued to be the case. The concept of cyclicality implies predictability, and predictability when applied to stock prices implies profits—consistent, non-random profits. This approach, along with other methodologies from a number of other active managers I have uncovered, have placed me firmly in the active management camp. Since the study was published, easier access to big data and the low cost of computer power have allowed serious students of the markets the ability to define shorter-term cycles in stock prices and to use quantitative analysis to discover opportunities within the long-term cycle.
Hortz: Well, here we are 40 years later still arguing “active” versus “passive” investing with flows shifting—aided no doubt by the coming DOL fiduciary rule—increasingly to lower cost “passive” investing options. Why are we still embroiled in the same debate?
Mann: The debate continues because the size of the money management business has become so large that successful managers are increasingly restrained from pursuing absolute returns. They are often structured around asset allocation and style boxes. Each manager is seeking to perform as compared to their peer group. Managers have been educated and are duplicating efforts over buying stocks based on forecast earnings growth and business performance. The size of these funds often leads to a portfolio owning a great many stocks just like an index fund. These funds usually have total costs much higher than index funds, leading to a poor comparison, but what about the potential for wealth creation?
There are active managers that have wealth-creating performance. A fairer comparison for this debate would be to compare index funds to unrestrained active asset managers. In truth, the really great active managers are not found in great quantity because many managers have been educated or forced by industry convention to seek relative performance. Investing to create wealth usually means not correlating to indexes. It requires patience from the investors to hold during times when the index performs and the portfolio does not. In addition, volatility might be higher than the index at times. I have found that the best active managers often protect account values better than an index during big market declines like 1987, 2000, 2008.
Hortz: You have mentioned in our discussions that your continued research and money management offerings have now included putting together a consortium of proven specialty active managers. Please tell us a little more about this group and the criteria you use in determining new investment managers to include?
Mann: In the process of marketing my investment services to other advisors, I found a few relatively small advisors who were either doing better than me or offered a different type of investment methodology that offered a risk/return profile that was very special. I am looking for active managers that have exceptional performance, [are] not over-diversified, are small and could use some more exposure. The difference between index performance and a manager like this should be easily observable. We want to help qualifying managers get their message out to independent advisors by offering distribution services and strengthen our overall investment offering at the same time.