|
Page 1 of 5
It used to be fairly simple. There was active management and then there was passive management, with enhanced index schemes floating in the narrow demilitarized zone between the two. Now, with the explosion of exchange-traded products and the advent of more and more complex indexes, that gray area separating the two philosophies has steadily expanded. The Journal of Indexes recently presented some questions on the subject to a group of experts on both sides of that divide.
John Bogle, founder, The Vanguard Group
Journal of Indexes (JOI): Where is the line between passive and active management, and where does it begin to blur?
John Bogle (Bogle): At one extreme, you can take an all-market index fund—all U.S. market or all global market as you wish—and do nothing with it; that's the extreme of passive management. And that is the position that I endorse.
I suppose the most extreme active management is characterized by high cost, high turnover and great tax inefficiency—let's call it high-cost hyperactive management. That is at the other extreme. The blurring comes when you take, for example, a passive fund and trade it actively.
In other words, if you're trading the S&P 500 Index all day long in real time, that's a passive strategy, but an active implementation. And so that's a big blurring; you lose the value of passive management when you do that.
The second part comes with passively managed investments in other countries, in small segments or in industrial industry sectors. Even though a Technology fund is run passively, for example, the line is blurred [in terms of owning the fund] because it's a passive approach to only that portion of your portfolio, and then it's an active approach to implementation again.
[Investors should] own the market, keep cost out of the equation and above all, not allow the true miracle of compounding return to be overwhelmed by the true tyranny of compounding cost.
JOI: Is the increasingly active use of index products harmful or beneficial to traditional buy-and-hold index investors?
Bogle: I think if traditional buy-and-hold index investors continue to be traditional buy-and-hold index investors, the active use of index products will have no impact on them one way or the other. The risk of harm would come if traditional buy-and-hold investors started getting enticed by the romance or the speculative thrill of using index products actively. So, as long as they don't do that, it shouldn't matter. For long-term investors and traditional buy-and-hold index investors, the impact is zero.
JOI: How has the growing acceptance of ETFs by advisors changed the way they manage portfolios? And is that good or bad?
Bogle: Well, none of us really knows how significant that change has been. It certainly seems that there is a group of advisors who rely much more heavily on buying industry sectors through ETFs, or maybe even these highly leveraged ETFs that make you go up or down much faster than the market. I think that it has changed the way advisors manage their portfolios a little bit, but I don't think it's necessarily bad.
The question about ETFs really should be: When advisors are using them, are they using them to do intelligent things?
JOI: How granular should the average buy-and-hold investor be?
Bogle: If by "granular" you mean how much you should focus on those small units of the portfolio rather than the total portfolio, I'd say, "Granularity: Forget it." I am an all-market indexer, and I've seen too many occasions when betting on particular sectors of the market goes awry—in part because we all think we're smarter than we in fact are, in part because the market is highly efficient. I want to be clear that I did not say, "perfectly efficient," because we have seen many, many inefficiencies in the markets from time to time. But in general it's quite an efficient vehicle. So holding the market is the ultimate strategy. And betting that you can outguess the market by holding more Energy stocks, or more Financial stocks, or more Technology stocks, or more Industrial stocks, is, I think, on balance a loser's game for investors.
JOI: Is qualitative active management dead?
Bogle: We really have three kinds of management. We have passive management—buying the market and holding on to it forever. And then we have active management, divided into qualitative and quantitative. Indexing is maybe 15 percent of the total stock market, traditional (qualitative) management is about 70 percent of the market and quantitative active management is the other 15 percent. Quantitative active management has kind of fallen on hard times. It turns out that massaging the numbers until hell freezes over doesn't necessarily make you a better investor.
Qualitative management had a very difficult year last year, as a number of well known managers struggled. But that doesn't mean that qualitative active management is dead. It's merely dying, losing a bit of market share year by year as investors awaken to the economics of investing. But it's never going to completely die, because there will always be someone for whom hope springs eternal.
|
