Implementation Innovations

“Nothing is certain but death and taxes,” seventeenth century author Daniel Defoe famously quipped. In the investment world, we believe there is another item to add to that list:  fees. Fees are inevitable; the expected value added from hiring an active manager is not.

A recent article in the Economist points out that the costs of hiring active managers are higher than most investors realize. Paying fees to active managers does not always pay off. In fact, in many cases, active management actually costs the investor money relative to what can be accomplished by investing in an index fund, where appropriate. For the five-year period ending June 2013, Standard & Poor’s SPIVA reports that in seven different categories, active management consistently underperforms index funds, as illustrated below.







Source: Standard & Poor’s SPIVA ending June 2013

At Balentine, we focus on controlling the fees that clients pay to implement our advice. We therefore recommend that clients use a combination of active strategies and passive index exposure. Typically, but not always, passive index funds are difficult to beat in highly efficient asset classes (such as domestic stocks and bonds), and we reserve our clients’ fee budget for more inefficient asset classes where the odds of managers bringing their skill to bear successfully are higher.

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 includes:

  • How closely managers track the exposure we wish to initiate;
  • Total expense ratio;
  • Liquidity
  • Structure;
  • Credit/counter party risk;
  • Tax efficiency for taxable investors;
  • Use of derivatives vs. underlying securities;
  • Share class; and
  • Internal efficiency and rebalancing methodology.
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