The Wall Street Journal Series on Active vs. Passive
During the week of October 17-21, the Wall Street Journal published an excellent series of articles on the topic of active vs. passive investing. Of course, the primary theme was the continued ascent of passive (or indexing) at the expense of active, which is largely explained by the continuing disappointment of active performance. Specifically, over the decade ending 6/30/16, between 71% and 93% of active U.S. stock mutual funds, depending on the type, have either closed or underperformed the index funds they are trying to beat, according to Morningstar data. Today, 34% of mutual fund and exchange-traded fund assets are passively managed compared to 16% ten years ago. Vanguard’s Total Stock Market Index Fund (the largest passive portfolio) now has $469 billion in assets, nearly as much as the four largest active funds combined. In fact, the largest managers of passive funds such as Vanguard Group and BlackRock Inc. now control substantial percentages of publicly-traded companies and heavily influence their corporate governance.
The March shareholder letter from Cohen & Steers, Inc. put it in a manner reminiscent of Ronald Reagan’s portentous statement about the Soviet Union: “It is time to acknowledge the truth, stock picking in its current form is no longer a growth industry. Active-fund firms that don’t position themselves for the sea change will be relegated to the dustbin of history.” It reminded me of DFA co-founder Rex Sinquefield’s famous comparison of active fund managers to leaders of Communist countries, based on the idea that neither of them can accept the notion that markets work.
The series provided numerous examples of people with fiduciary responsibility for retirement funds switching from active to passive. Given the enormous difference in fees and the disappointing performance of active funds, it would be difficult for them to justify any other decision. My favorite example was Steve Edmundson, the CIO of the Nevada Public Employees Retirement System, who switched entirely to passive. The article about him was titled “What Does Nevada’s $35 Billion Fund Manager Do All Day? Nothing!” Instead of paying $120 million in annual investment expenses, the fund pays $18 million. In terms of risk-adjusted return, Nevada ranked sixth in the nation.
For me, the highlight of the series was Jason Zweig’s excellent article about Dimensional Fund Advisors (DFA), “The Active-Passive Powerhouse”. As the title suggests, DFA incorporates elements of both active and passive. One problem with traditional indexing is that following a list of stocks like the S&P 500 or the Russell 2,000 can lead to problematic trading situations which DFA avoids. As Zweig points out, DFA often benefits its shareholders by following a patient and flexible trading strategy. Combining this with precisely engineered funds designed around the risk and return factors of size, relative price, and direct profitability lead to expected returns in excess of the overall market. With $445 billion of assets under management, DFA is now the sixth-largest mutual fund manager, up from eighth a year ago, according to Morningstar Inc. On a percentage basis, DFA has consistently been the fastest-growing asset manager.
At Clarity, we are pleased to be among the select advisors approved to utilize DFA’s funds for our clients. If you would like to learn more about our approach to investing and how we can help you, please call us at 800-345-4635.