Norway is now trying to figure out whether they should continue to use active managers or go to passive management. Their crisis came about in the financial meltdown when their previously successful active managers lost a slug of money. Now they are wondering whether they should just save the fees and use a passive approach.
I must confess that I’ve never completely understood this argument. Sure, an active manager can lose when the market goes down-but a passive manager is guaranteed to lose also. Fees are never pleasant, but as the old saying goes, “the bitterness of poor service lingers long after the sweetness of low cost is gone.”
The base question is: are you getting what you pay for? Clearly, it makes no sense to pay a closet indexer the full fee for active management. We’ve written about this before, and it’s true that closet indexers are a large part of the industry. No, you need to find a manager out of the mainstream with a high active share. It means you won’t track the benchmark very closely at all, but you’ve got a very decent shot at beating the market according to the research.
And despite what John Bogle and other EMH apologists say, there are plenty of strategies that do beat the market. Mark Hulbert of MarketWatch addressed this recently:
My three decades of tracking investment advisers has shown that, over long periods of time, about one out of five advisers are able to do better than simply buying and holding an index fund. While that means it isn’t impossible to outperform the market over the long term, the odds are stacked against us.
That 20% number sounds about right to me, and obviously Mr. Hulbert has the data to back it up. The 80/20 rule holds just about everywhere else; I don’t know why investment management would be any different.
If, instead of resorting to passive management, you dedicate yourself to finding that superior 20% of the industry, it could be quite rewarding, not to mention a lot less boring than settling for mediocrity.
