The Active Passive Debate Evolves by Necessity
By Roger Nusbaum, AdvisorShares ETF Strategist
Daily Alts took a stab at the topic of evolving asset allocation and the blurring of the line between active and passive citing work/theory done by Eaton Vance. As a starting point, and something we’ve been talking about here for several years, the basic 60/40 may be losing some of its effectiveness especially on the 40 side, the fixed income portion, because interest rates are so low and as we learned from the most recent Fed statement may stay lower for longer. The article also considered a blurring of the line between active and passive management.
As a quick side note, Cullen Roche has an interesting idea about the definition of true passive management which is that any portfolio that does not own the asset classes in the weightings of the issues outstanding is in fact an active portfolio. By his reckoning (as of the last time I read a post from him on the subject) that would mean a little under 50% in global equities and I believe a whole lot of Japanese and US debt. There is no fund that tracks this sort of truly passive allocation but it is an interesting point. Others have said that rebalancing is an active decision with logic being that if stocks drift higher as a percentage of the capitalization of asset classes than rebalancing away is a decision to move away from the weightings in the natural market.
This would make Jack Bogle and his stay away from foreign an active investor not a passive investor. Hence the blurring of the lines.
Anyone whose read this site for a while will know I believe in active management but the context of active/passive is not solely about whether active can beat passive. Beating the market is not the true objective of most investors. The true objective, even if they don’t realize it, is having enough money when they need it. As I typically say in this type of post; without looking what did the market do in the second quarter of 2013 and how did your portfolio do? You are very unlikely to know that answer, without looking, because it does not matter. If you are on track you know it and that is important and if you are not on track you know that as well and that is also important. However wrapped up anyone might be about the current quarter, two or three years from now you won’t remember this quarter either.
When an investor can truly embrace that they need to focus on meeting their objective as opposed to beating the market they will invest more suitably which to me means a mix of different types of products that when blended together seek a particular outcome. For some that might mean less volatility than the market which is certainly an active objective or some sort of yield oriented strategy which again is an active objective. Most diversifiers are arguably active strategies, how passive is some sort of diversifier that tracks a recently made up index? If the bond market is becoming more complicated then active strategies there make sense and we are seeing the big ETF providers offer actively managed funds as well as funds that are clearly intended to be used as part of an active strategy; no one is going to index to a passively managed corporate or muni bond fund that matures in 2018 or 2021 but they can use that type of fund to manage a portfolio’s average duration or credit rating.
I would say that a fund that tracks the S&P 500 or some total market equity index is a passive vehicle but most people don’t use them passively, by Cullen’s logic, no one uses them passively. The lines are blurring because it is becoming more widely accepted that it is the outcome that is important and ties in with Eaton Vance’s point in the above linked article. This is not a new concept but is an increasingly important concept.