Is the era of passive index trackers over?

older_and_no_wiser

I was listening to a finance podcast earlier (Money to the Masses ep. 370). They went through the 10 commandments of investing. During that they quoted a Wall Street "guru" who was saying that he feels that the way the markets are heading, the era of global passive index trackers performing the best may be over and that now it's the time of active funds with managers who can pick well in different themes (whatever that could mean!). 

Any thoughts? 

tacpot12

I can't say I find the guru's insights very insightful.

A 'good' active fund should always outperform a passive fund, but this assumes that the active fund's charges don't absorb the 'extra' performance of the fund over the passive equivalent - too many active funds have charges that exceed the extra performance that the fund might offer, so end up delivering worse returns than the passive equivalents. 

Also active funds, and their managers, can always be hit by bad luck. Their stock picks might fair worse in a pandemic or global downturn than the average, even if all the analysis suggests the company should be a good investment. Passive funds investing in a whole market might fair better due to averaging the effect of problems across the entire market. 

I don't see Passive vs. Active as being an either-or question. I favour Passives for some markets and Actives for others.

What we are seeing in the US, where stocks were significantly over-valued, is a significant market correction. I don't think many Active funds will have avoided losing significant amounts either, and you still pay the higher fees even when the fund has lost money! 

MX5huggy

Passive funds have never been the “best”. Just you don’t know which funds will be better. 

ColdIron

It's a salt or pepper argument, no one should use one to the exclusion of the other

dunstonh

 During that they quoted a Wall Street "guru" 

That suggests American.   In America, the taxation system makes it very hard for managed funds to beat passive.  So, you need to be wary of using US sources as a UK investor.

 now it's the time of active funds with managers who can pick well in different themes (whatever that could mean!). 

It's an old argument and has been correct in some negative periods but also wrong in others.  There is no reason to change your view on active vs passive because of recent events.

Audaxer

I definitely don't think it is over. Passive global index trackers have not fallen as much as most global active growth funds and ITs this year, mainly because global passive indexes include value as well as growth. Anyone who was impressed by the high gains of some active growth funds last year and jumped on the bandwagon too late, might now be wishing they had invested in a passive index instead.

DoublePolaroid

Passive global index investing means average returns does it not? I’m fine with that, even given the expectation that the average return over the next decade will suffer significantly by comparison with the previous decade. 

The issue as always with picking active funds to beat the market is, how do you pick the winning fund managers, since the evidence suggests past performance is not an accurate guide? I’m happy to accept I couldn’t do it except by blind luck. I don’t think that will be any less true in the future than it was in the past, for me at least. 

Bravepants

A friend of mine told me, just before he retired at normal retirement age, that he was lucky he got out of Woodford when he did. Fund managers watch the stocks, but whowatches the fund managers?

JohnWinder

I guess they have to fill a podcast with something, and there are some well founded comments in those ’10 commandments’, but unpick it a bit.

10 commandments makes it sound more legitimate, or at least evokes the biblical 10 commandments and hopes to ride on their legitimacy, in a way that ‘8 commandments’ doesn't. And even the podcaster concedes that Farrell’s #2 and #4 are the same; and I’d say #1 (market swings return to a mean level) is the same as #2 (swings can be big).

#5 defines a strong market as one where the rises in the market are widespread rather than limited to few stocks. OK, that his definition of ‘strong’, but the commandments don’t take that idea anywhere so how is it useful?
#9, 'when experts agree, something else happens'. That’s vague enough to be almost meaningless for me.
And #10, so that there are 10 commandments: 'bull markets are more fun than bear markets'. If that’s the level of analysis it detracts from the value of anything else he writes.

And to the argument that passive did well recently because QE gave asset prices a big boost pushing all markets up, but now the boost is being removed passive will do less well: that could well be true. But he takes it a step too far when he goes on to suggest now is the time when active can do better than passive. If active could, then is should have done it during the good times as well as the bad but that’s not what’s happened, as a broad generalisation. 

If you write stuff to get readers, you can sell advertising. That's the financial press business model. How many readers would they get if they wrote 'the most secure returns are market returns which passive investors can get', every day? Too boring, un-sexy.

ChilliBob

Bravepants said:

A friend of mine told me, just before he retired at normal retirement age, that he was lucky he got out of Woodford when he did. Fund managers watch the stocks, but whowatches the fund managers?

That's actually an interesting one which Ramin from Pension Craft often mentions - etfs like Ark don't have to justify themselves but the likes of SMT have a board which they need to be accountable to. It may not make too much difference but its an interesting distinction between the two structures.

In response to the question though.. I think it depends, overall I think passive in the long term. In the short term, yes there will be active funds which beat passives. Eg RL Global Eq Select is active, and I have a decent sized holding in it.. It is holding up better than a global tracker for now but who knows for how long? If its over taken I get the sense it won't crash and burn like say EWI or SMT

Linton

If you are investing money that really matters to your future well-being your investment strategy should be based on meeting your financial objectives at minimum risk rather than worrying about what your chosen index is doing.  Chasing excess returns beyond those necessary adds to the risk that you will fail.
 
You should choose the most appropriate set of funds to achieve the objective.  In principle they could be active or passive, either could be appropriate in the right circumstances.  Both have risks.  With active funds the manager may change strategy or not have a clear strategy at all.  With passive funds the asset allocation may not match your needs.  For example 60% US seems an unnecessary risk as does their following of the fashions.  Look at the .com boom/bust or 20 years ago which Woodford's value focussed strategy avoided completely, perhaps current events ae similar.

So to answer the question, "eras" are irrelevent.  Do what is appropriate for your objectives.