This style of management – let’s call it ‘Passivity’ – is now deemed a cheap and relatively innocuous way to gain exposure to real assets, relative to more expensive and ‘riskier’ actively managed peers.
However, this is a specious description. Passive implies restful, docile and unreactive. Passivity is none of these in principle – its investors are tossed around by market forces, with no commander to put up a defence. The tracker ‘yacht’ sails with no destination, no captain, with or against the wind, and with no rudder. There is no skill involved, since no decisions are made. The yacht goes where the wind takes it.
‘Active’ on the other hand, suggests the process is defined by activity, e.g. market timing, trading etc. This is a common misconception about investment management, and unfortunately tars all managers with the same speculative brush.
The ‘active’ process is in fact selectivity, not activity – choosing which constituents of a market to buy, to what extent, and what to reject. Indeed, this is what makes the market, sets prices and steers capital to companies with higher earnings. A market economy requires selectivity; it’s the catalyst for value generation. It protects all investors by efficiently setting security prices and providing trading liquidity; it also offers the potential for better risk management for individual investors.
Passive investors meanwhile are free-riding speculators, paying only the marginal cost of market participation. They don’t bear any of the costs associated with making fair prices; consequently they don’t support the real economic purpose of financial markets. Passive disciples could care less about the economy. They believe selection is a waste of time.
The Passivists’ bible is ‘The Efficient Market Hypothesis”, or EMH. EMH postulates there is no mispricing in markets, and therefore no exceptional returns are possible. However, this mantra hides a huge contradiction.
Economics is concerned with the production, consumption, and transfer of wealth. It regards that process like an engine, with economists acting as the mechanics monitoring the engine’s performance diagnostics. As a plethora of data is gathered on growth, inflation, etc, this prompts those mechanics to slow the engine by turning up interest rates, or speed it up by injecting more fuel, ie money supply. They believe the engine parts – you, I, and everyone else circulating money – create an unstable, never-idling engine if left to our own devices.
But if the economy is efficient by definition, then one might be forgiven for thinking it is where it’s supposed to be? Perhaps economists’ believe all markets – that’s you and me – are efficient, but that the public just not as clever as economists.
