On the heels of my last diatribe on why traditional "active" management is relatively doomed, let's get into what does work.
Passive management, two words that give most investors (especially us professionals) fits of resistance and even derision. After all, who really wants to be considered "passive" at anything? Humans are born from and have to live to a high level of activity and so we by nature and evolution believe that given a binary offering: active vs passive, we head naturally to active. Add in some degrees and certifications (CFAs, CFPs, Series Licenses, etc) and active becomes your mantra.
Not to worry, here is a path to understanding why there is nothing passive about what the industry has connoted as "passive" just to drive many to default to "active" for a host of possibly self-serving reasons.
Five reasons passive is the new active:
Based on price reflects current, unbiased market assessment of company value
Prices change daily which causes the weight on a security in a portfolio to change also
Plenty of volatility with generally unbiased participation in both upside and downside volatility
"Alpha" generation relative to using traditional active; that's right, bet against the other side getting it right
No hedges, no cash; always exposed
Basically, what has happened is this: what was considered "active" management is now too passive (read: invalidated) due to the fact that it is not active enough to overcome its inherent inefficiency in a highly liquid marketplace. Hard to fathom but SPIVA results confirm such a conclusion. Oh, the humanity!
Somewhat anecdotally, a $50B quant-based indexing firm we have eminent respect for, Intech (now owned by Henderson Janus), is running into this issue even though they have used a mathematical construct and daily rebalancing since inception (1987). Look at their alpha generation and you will find a similar performance degradation in the 2000s as they scratched their Phd-inspired heads to figure out why the math isn't working anymore. But, the answer is relatively simple, their investment thesis/engineering requires they set a return target for a portfolio. This inherently sets the portfolio up to lose inside the black hole (as written about last month) of traditional active investment management. Keeping in mind that "losing" in this case is only about whether there is any net alpha as a function of their active process.
Moral of this story: there is plenty of real active in traditional passive and traditional active is too passive. If you desire alpha and lowered risk, push further into the non-traditional "passive" space and seek more bang for your investment buck.
And, have a great Thanksgiving too!