On Saturday May 2nd, millions of viewers tuned in to watch Floyd Mayweather and Manny Pacquiao duke it out in the boxing ring. While many were left disappointed at what had been billed as the “fight of the century,” Jason Zweig of the Wall Street Journal contends that the real heavyweight match of the year took place not in the ring but on the stage of the Grant’s investment conference. The players: James Grant and John Bogle. The topic: active v. passive investing.
By way of background, Jack Bogle created Vanguard in 1974 and grew it to the second largest mutual fund company in the world, managing more than $3 trillion. Jim Grant publishes Grant’s Interest Rate Observer, a twice-monthly journal discussing financial markets and widely read, Zweig writes, by many active managers. According to “Bogle vs. Grant in the Great Fund Debate,” after months of verbal jabs in the media, Bogle and Grant finally went head to head on active vs. passive investing. Throwing metaphorical punches much more ferociously than either Pacquiao or Mayweather, Grant, according to Zweig, claimed indexing is now for the uniformed, unimaginative masses, while Bogle asserted that active investing is too expensive and that indexing is a result of innovative technology, not a passing fad.
These two represent the extremes since their firm’s business models and own livelihood depend on it. For most investors, however, such a polarized view is not necessary. There are places in the portfolio for both. We urge clients to focus on the things they can control, one of which is fees paid to implement investment advice. As we described in the synopsis of our Fifth Anniversary event with Charles D. Ellis, implementation fees relate to the costs of actual funds or vehicles an investor purchases to express that advice and can be either active or passive. By virtue of its name, passive investing evokes a negative connotation. However, as Bogle points out, technology has made many areas of the investment landscape more efficient. In these cases, passive investing (aka indexing) has become a more cost effective, better-performing alternative. SPIVA® Scorecards consistently show that active managers are underperforming their respective indices across a variety of asset classes.
This does not mean that active investing is obsolete. Instead, according to Mr. Ellis in his article “The Rise and Fall of Performance Investing,” the onus is on the investor or his/her adviser to find a manager who is “more hardworking, more highly disciplined and more creative than the other managers…and more by at least enough to cover the manager’s fees and compensate for risks taken.”
At Balentine, we marry these two approaches to achieve what we believe is the most effective blend for our clients’ portfolios. We typically choose passive indexing for highly efficient asset classes and save active management fees for less efficient markets such as hedge funds and private capital or in situations where we need a manager to be highly selective and nimble versus an index which would have exposure to a broader and riskier opportunity set.
However, the use of passive index funds is not always as simple as it sounds. Not all passive index implementation vehicles are created equally, and passive management requires active due diligence. When evaluating index funds, some of the criteria Balentine’s Investment Strategy Team uses include
- How closely managers track the exposure we wish to initiate;
- Total expense ratio;
- Credit/counter party risk;
- Tax efficiency for taxable investors;
- Use of derivatives vs. underlying securities;
- Share class; and
- Internal efficiency and rebalancing methodology.
While the fight between Grant and Bogle may have been more exciting than Saturday’s pay per view extravaganza, in the end, it is for naught. Both have valid points, we contend, and in the end, a place in client portfolios.