The most ubiquitous styles of active management -- such as value, quality and momentum -- have historically beaten the broader market. The problem is that active managers kept the profits for themselves by charging investors absurdly high fees.
Those active styles are now available in the form of systematic, low-cost index funds that are just as cheap -- and in some cases cheaper -- than passive funds. The Vanguard Value ETF, for example, tracks a large-cap value index and charges just 0.06 percent annually. That’s less expensive than many Standard & Poor’s 500 mutual funds and barely more expensive than the cheapest S&P 500 exchange-traded funds. There are many other examples.
So active isn’t necessarily more expensive than passive. And because cost and performance are so closely related, I suspect that active management will deliver far better results going forward than it has in the past.
BR: We agree on factor investing and that some people beat the market; we also agree that general low-cost, outperforming active management can and does exist -- look at Bill Miller, Warren Buffett or your own track record as proof of that.
But we have to separate the general average manager from the specific individual manager: On average, most of the lower costs and most of the market performance are on the side of passive investing. The average active manager is expensive and typically underperforms their benchmark. The latest studies suggest that it is even worse than we previously believed over longer periods of time.
People are not that good at picking stocks that can beat their benchmark; nor are they especially good at finding the stock-picker who can beat their benchmark. Some even pick a professional to pick the fund managers who will pick the stocks that beat the market.
How can anyone identify in advance who will outperform? And when an outperforming manager is located, how can you know he or she will continue to outperform? How can an investor tell when it is luck or skill? What rules should you have for jettisoning a once-outperforming manager who no longer is outperforming?
I think we both agree that expensive and underperforming active gives the entire complex a bad name.
NK: I certainly agree that most actively managed funds are still too expensive and therefore unlikely to beat passive funds.
Investors have gotten the message. According to Morningstar, they pulled $578 billion from traditional actively managed funds and plowed $1.4 trillion into low-cost funds since 2015 through July.