David Evanson and Oliver Pursche
Forbes.com, Winter, 2013
I attended a celebration for the 20th anniversary for the creation of the first exchange-traded fund ever, State Street’s SPDR S&P 500 ETF (SPY) in Manhattan on Tuesday.
It was a lush affair, as perhaps it should be, given the milestone marked an indelible change to the investment landscape.
It also provides the context to finally answer the question that has burned ever since index or passive strategies came into existence: Which is better, active or passive management?
This answer is . . . drum roll please . . . active management.
Active management is superior by default because passive management is only theoretically possible.
In my 20-plus years managing money I have not met a single investor who put all of their cash into a broad market index, ad infinitum. Rather, they combine them with bond indexes or funds, or peel back on the large-caps inherent in SPY, and add a concentration of small- or mid-cap focused investments. And by doing so, they become – de facto – active managers.
That said, there are some very challenging aspects of active management that investors need to keep in mind. Specifically, investors fortunate enough to pick a top performing equity mutual fund manager will find there’s a very good likelihood that he will no longer be a top performing manager one year later.Five years later, the likelihood is so small that it could be characterized as a rounding error.
The numbers underlying this assertion come from the so-called SPIVA analysis, where SPIVA stands for S&P Dow Jones Indices versus Active. It’s the information giant’s best attempt to get an apples-to-apples comparison of how active managers stack up against indexes.
Specifically, the analysis suggests for a mutual fund whose performance was in the top quartile of all domestic mutual funds in September of 2010, there’s a 90% chance that by September of 2012 the fund’s performance was somewhere among the bottom three quartiles. Similarly, if you picked a mutual fund whose performance was in the top quartile of all domestic mutual funds in September of 2008, there’s 99.82% chance that the fund’s performance would be somewhere among the bottom three quartiles by September of 2012.
There are several reasons that prevent active managers from consistently staying on top. They include the cost of information, so called “closet indexing,” and restrictions imposed by the fund’s charter.
My advice to investors is to forget the debate, accept that 99.44% of us (the same purity by the way as a bar of ivory soap) are or employ active strategies, and remain agnostic with respect to product designation. Far better, I believe to start with portfolio objectives, and then find the products which will help your reach your goal.
As a card carrying active portfolio manger, that’s certainly what I’ve done to meet the objective of the GMG Defensive Beta Fund.
Here’s a list of so-called “passively managed” indexes we own to fulfill our mandate to provide long-term capital appreciation with less volatility than broader equity markets. All totaled these investments constitute about 31% of our holdings.
SPDR S&P 500 (SPY)
PowerShares DB Agriculture Commodity (DBA)
PowerShares DB Energy Commodity (DBE)
SPDR Gold Shares (GLD)
iShares Silver Trust (SLV)
ETFS Physical Palladium Shares (PALL)
ETFS Physical Platinum Shares (PPLT)
United States Gasoline ETN (UGA)
SPDR Barclays Capital Short Term High Yield Bond (SJNK)