19 Aug 2019
According to Moody’s, total assets in passive funds in the US will overtake those in actively managed funds in 2021. In light of this significant moment being almost upon us, I thought it would be interesting to write about the predictability of financial markets - the basis of active management - and some of the key protagonists.
That it is possible to add substantially more value to our customers’ portfolios than we subtract from them in fees is the basis of our business. The debate between those who believe that markets are efficient, and thus unpredictable, and those who don’t will continue to rage on, and we, as a boutique active manager, seek to be part of it.
The battle lines in this debate, however, are drawn in a somewhat puzzling way. To the passive world, all those seeking to ‘beat the market’ are fools. Yet I do not denigrate the passive world in the way it denigrates mine. I believe that, for many, passive investing makes sense.
The apparent anomaly lies in differences of opinion with respect to the nature of the ‘game’ being played. To the passive world, investing is a game of luck, so by definition theirs is the only worthwhile approach. Accordingly, they must disparage all others. To the active world, on the other hand, investing is a game of skill, in which there is no ‘house’, only other players. Not everyone, by definition, can win.
If we can be better than, say, three quarters of our competition, we will almost certainly generate returns, net of fees, well in excess of the relevant index or passive equivalent, and thus over time ones that are respectable in absolute terms – it is nice to see our two OEICs now posting alphas, Sharpes, and information ratios well above those of their Vanguard equivalents over three years.2
Our challenge is thus to be more skilful than other active managers, then to articulate clearly to our customers our investment approach - success for an active manager relies as much on the power of persuasion as the power of prediction.
The passive world has something to offer because index funds do what they say on the packet – provide index performance. Furthermore, there will always be fund investors who lack the time, tools or inclination to identify skilful active managers and thus for whom an index fund is the sensible option.
It is somewhat ironic however that the constituents of index funds, namely companies, are all trying to do one thing: beat each other. Few would question that this competition is anything other than a game of skill and hard work. The better companies tend to stay at the top, whether in toothpaste, cars, computers, active management or passive management. The ultimate paradox may be that Vanguard is not seeking, like its products, to be average, but to beat iShares!
It would be nice if we lived in a world in which all companies win. Until then, we will continue to strive to beat our competition by a wide margin and in doing so give our customers value for money. This letter and the next three are part of that endeavour.
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