There’s nothing intrinsically wrong with active fund management. Larry.
There, I said it. I’m actually quoting the investment author Larry Swedroe on the latest Intelligent Adviser podcast, but I happen to agree with him.
Before you start thinking that Larry and I have lost the plot, let’s back up a little. What Larry actually says is this:
“Active management isn’t bad in and of itself. On a gross basis all investors have to get the same return, whether you’re active or passive. Active underperforms simply because it has higher expenses.”
That, in a nutshell, is the problem. If active managers were willing to sacrifice some of their profit margins, cut their operating costs (particularly salaries, bonuses and marketing) and substantially reduce their funds’ expense ratios, there may be a case for investors who are willing to take a punt including a small element of active management in their portfolios. It is, however, a very big if.
I say there may be a case because it depends on other factors too. As Larry explains, to be considered for inclusion in an evidence-based portfolio, an active fund would also have to:
- have high Active Share;
- have very low turnover;
- trade in a flexible but systematic way;
- stick to its stated style; and
- resist any temptation to time the market.
Here’s Larry again:
“If you use an active fund that sticks to its knitting, and has very low turnover, then you have a good shot. The problem is, why do you want to cede control to an active manager? They could always change their strategy, style drift or decide to time markets, and those things tend to be negative.
“Even if you can find (a good manager), I can’t see a good reason to choose one because you always have good passive alternatives.”
So, does any fund management company come close to ticking all of Larry’s boxes? Yes, there is one — Vanguard. Sadly, for now, no other company comes close.
By using scale to reduce fees, and by ensuring that its managers keep to their stated style and to a high-conviction, low-turnover approach, Larry believes that Vanguard is at least giving active investors a fighting chance of beating the market net of costs.
Historically, Vanguard’s low-cost active funds have underperformed Vanguard’s index funds. Don’t hold your breath, but Larry says there are some asset classes in which that might just be starting to change.
Let’s be absolutely plain: this is emphatically not a recommendation to start buying low-cost active funds. Remember, Larry still can’t see a reason to choose an active fund over a passive alternative, and nor can I. Nor is there any escaping the zero-sum game; no matter how far fees and charges come down, the average active investor must underperform the average passive investor net of costs.
But if more firms follow Vanguard’s lead, there may be a glimmer of hope for active management. It’s certainly something that we at TEBI are going to be monitoring very closely in the months and years ahead.
I do encourage you to listen to the interview with Larry Swedroe, which I think you’ll find fascinating. As well as active management, Larry also talks about his career in finance, what gets him out of bed in the morning, and why people need to pay far more attention than they do to the non-financial aspects of planning for retirement.
You can listen to the podcast here:
https://soundcloud.com/user-421101742/the-intelligent-adviser-ep-12
You’ll also find the Intelligent Adviser podcast on iTunes.
Please do share this podcast, and why not leave a review? We would really welcome your views on what Larry has to say.
Robin is a journalist and campaigner for positive change in global investing. He runs Regis Media, a niche provider of content marketing for financial advice firms with an evidence-based investment philosophy. He also works as a consultant to other disruptive firms in the investing sector.
