Really? Active Management Is Dead?

A different take on an old story.

Jim Bianco has a post up for Bloomberg that stops just short of proclaiming active management as being dead forever. He cites several factors including a lack of interest in working in the field by recent college graduates, poor relative performance for active managers in this cycle (although he seems to be focusing on hedge fund managers), there are more flows going into indexed ETFs (although AUM in traditional funds is still far ahead of ETFs) and many active managers having the wrong motivation.

I credit Cullen Roche for pointing out that there is no such thing as passive. Simple rebalancing is an active decision. Whatever someone's process/thresholds for rebalancing, they are making an active decision. Whatever someone decides is their suitable asset allocation is an active decision.The closest someone is going to realistically get to passive is using passive funds and making changes very infrequently.

Choosing to use only the cheapest, broadest index funds for a portfolio can of course get the job done for meeting some sort of long term objective. There are countless other ways to meet long term objectives as well. The story of how well active management is or is not doing and whatever the future might be for active managers broadly or superstar managers more narrowly it doesn't really matter to you the individual investor trying to build up your retirement fund or you the adviser trying to help clients build up their retirement funds.

I am not saying you should use active funds or you should use passive funds, I have no dog in that fight any longer, if I ever did (more on that coming in a subsequent post). I would reiterate the point I have been making on this topic for as long as I have been writing which is that it isn't logical than one wrapper can be the best thing for all exposures at all times. For equity exposure I use a mix of individual issues (clearly active decisions) and sector/thematic ETFs that track indexes (I can't imagine there is a compelling argument that indexed sector/thematic funds actually fit into what someone believes is a passive strategy). For fixed income I use a mix of individual issues, indexed ETFs and actively managed products. For alternatives I use a mix of indexed and active products.

Like any investor or adviser, I use what I believe are the best vehicles for each of the exposures I want for clients. Where a portfolio is a series of decisions, some of which will be right and some of which will be wrong, I of course get some wrong sometimes.

Another crucial aspect to this conversation is that all strategies have flaws or things they are vulnerable to. Owning index funds has been a great hold for quite a few years but as has been the case in previous cycles, the market cap weighted indexes have become top heavy in a few mega cap names. Amazon has of course been one of the stars of this bull market and has grown to have a 2.69% weight in the S&P 500. During the financial crisis the name fell 60% and during the tech wreck it fell 90%. It is not unreasonable to think some sort of dramatic decline will happen in the next bear market. That is not a prediction, just a recognition that often the top performers get hit the hardest to the downside. Where the S&P 500 is top heavy in the FANG stocks would really be a surprise if something bad happened with the whole theme...the leadership of that market cap weighted index? This possibility doesn't invalidate indexing or the companies, it is merely a risk to be aware of.

Any other strategy you could bring to the table would have its own flaws or drawbacks. What gives you the best chance to get to where you need to be and really the big part of it is what can allow you to sleep at night because for their drawbacks, they can all get the job done even if only one strategy will end up being the best performer over the time frame relevant to you. Meaning, that if you are an indexer you can still accumulate enough for retirement even if some flavor of active turns out to be better.

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