10/05 12:08 ET
Inigo Fraser Jenkins of AllianceBernstein famously calls passive investing “communist-style” investing.
What do you have to say about that? Is it more Xi Jinping than Warren Buffett?”
John Authers, Bloomberg Opinion, New York
10/05 12:10 ET
What a wonderful attack! The best I can say is that it’s nonsense.
First of all, “passive investing” is a great misnomer. It was invented by a couple of guys who were electrical engineers, and everyone who’s in electrical engineering knows that, to connect an appliance to the power source, you plug the active end, which has two or three prongs, into a passive end, which has two or three holes. It has no emotional impact of any kind.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:11 ET
Take that same terminology and apply it to investment management, and it takes on great power. Who would like to be introduced by his or her spouse as, “she or he, is passive”? Or: “Tom Brady may be a good quarterback, but our quarterback is excellent. Our quarterback is passive.”
None of us wants to be passive. But if you go past the mudslinging and insult-generation, indexing has a lot going for it.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:12 ET
Over a reasonable time period, like 15 years, indexing will beat 90% of active managers, partly because it has lower cost of operation, partly because it has lower fees, and for individual investors of course it has lower taxes.
If our objective is to be in the top quartile, indexing assures us of success over a reasonably long time period.
What’s not to like about winning with so little effort?
Charles D. Ellis, Greenwich Associates Founder
10/05 12:12 ET
Besides, with the time freed up by not focusing on detailed operational questions, each investor can focus on the really important questions like asset mix over the long term.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:13 ET
Now turn the question around: If you were now indexing, would you be willing to change to “active” investing, knowing the odds are 90% against your keeping up with your market index, knowing that your taxes would be higher and knowing that the chances of falling short are not only high but painful because they are much larger than the benefits of those few who outperform?
Charles D. Ellis, Greenwich Associates Founder
10/05 12:15 ET
As passive grows in share of total, are there limits of passive as share of total where the cost might be increased market instability? Who can take the other side if, say, passive was 80% of the total?
John Authers, Bloomberg Opinion, New York
10/05 12:18 ET
This is a fascinating question. Many people think it’s the share of the total equity market that is indexed that really matters.
I don’t think so. Markets are made by people with different opinions, and so long as the number of people continues to be very high, and they are active in expressing their opinions, a very small percentage of the market not being indexed would be plenty.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:19 ET
Over the last 50 years, we’ve gone from roughly 5,000 people engaged in active investing to comfortably over 1 million people engaged in active investing. If that were to drop down to half as many as today, it might make some difference. But the reality is, more people join on the active investing side every year than withdraw or go away.
And candidly, the Darwinian process has been upgrading the talent pool year after year after year, and the extraordinary increases in the tools with which people engage in active investing -- think of the magnitude of change in computing power, the wide range of analytical models of various kinds, the power of the internet, the 330,000 Bloomberg terminals, the SEC regulation FD for fair disclosure, the increased number of CFAs.
When I graduated from Harvard Business School, there were no courses investment management. Now there are two dozen.
On top of that, investing has gone global.
Charles D. Ellis, Greenwich Associates Founder
10/05 12:22 ET
We have one slightly different question, about David Swensen, which also has much broader implications for asset management:
“There’s a story nobody seems to have written following David Swensen’s passing. While everyone covered his shift to illiquid investments, few, if any, wrote about his focus on aligning interests between clients and money managers. He did not like firms with more than one product or any form of outside ownership (especially publicly traded asset managers). These are lessons being forgotten by many allocators today; could Charley comment on this, please?”