Active vs Passive

Introduction

• Active vs passive – what’s in a name?
• Can anyone be truly passive? In search of the Global Market Portfolio

Active vs passive performance – the evidence

• USA
• UK
• Europe
• Japan
• Emerging markets
• Real Estate
• Bonds

Arguments for active management

• What is factor investing?
  • • Why do factors outperform?
    • Multifactor investing – part 1
    • Multifactor investing – part 2
• Valuations vs long term returns
• Risk parity
• Irrational markets
• You’re not human

Arguments for passive management

• Performance
  • • Active vs passive performance: The evidence
    • Performance persistence
• Why do passives outperform?
  • • In theory: Sharpe’s Arithmetic of Active Management
    • In practice: The predictive power of fees
    • The market is efficient
    • The market is becoming more efficient
    • Positive skew
    • Requires no forecasting
    • Has no minimum investment requirements
    • Has no capacity constraints (no style drift)
    • Doesn’t require picking winning fund managers in advance (luck vs skill)
    • Doesn’t require deciding whether to stick with underperforming managers, and has no temptation to chase the latest hot manager (lower behaviour gap)
    • Doesn’t incur the risk of a manager having to close/suspend/merge their fund (survivorship bias)
    • Has fewer conflicts of interest
    • Becomes more powerful the more people adopt it
• Other benefits of passive
  • • Transparency
    • Simplicity
    • Takes less time to monitor
    • Less stressful, fewer decisions required
    • ‘Beating the market’ is not a financial goal
• Problems with smart beta
  • • Part 1: The cyclicality of factors
    • Part 2: Defining a factor is hard
    • Part 3: Factors can change
    • Part 4: Factor decay
    • Part 5: It’s impossible to know when a factor stops working
    • Part 6: Factor dilution
    • Part 7: Academia is not real life
      • • 7.1: Factors are long/short
        • 7.2: Factors work better in small caps
        • 7.3: Trading costs
        • 7.4: The human factors
        • 7.5: Some examples
    • Part 8: Backtesting
• Valuations and timing the market
• Closet indexing and herding
• Peer group rankings
• Self-selecting benchmarks
• The uselessness of forecasting
• Focus on things you can control
• Asset allocation drives most of your returns

Debunking the myths of passive investing

• Is passive investing causing a bubble?
  • • The claim: Passives are causing a bubble
    • What is a passive investment?
    • The evidence:
      • • Sharpe’s Arithmetic of Active Management
        • The market share of passive investing
        • Is passive investing setting prices?
        • Passive investing and market crashes
        • Is passive investing making the market more concentrated?
        • Are large stocks getting larger?
        • Where are all the outperforming active managers?
        • Why passive investing is increasing market efficiency
    • Summary of the series
• Actives can help you avoid crashes
• Actives outperform in less efficient markets
• Passives buy all stocks, actives buy only good stocks
• Actives give a chance of outperforming
• Active management works for bonds
• Passives don’t contribute to price discovery
• Passives don’t allocate capital efficiently or manage corporate governance
• Passives reduce dispersion and increase correlations
• The market is irrational
• ‘We are not average’
• Passives are untested in a downturn
• Passives have only done well because of QE
• Passives are un-diversified
• Index tracking is momentum investing