passive management

Two Thoughts on Smart (or Strategic) Beta

Posted by Mike McLaughlin on Nov 17, 2015, in Thoughts , tagged with , , , ,

A few weeks back I commented in a story on OppenheimerFunds’ move into the smart (or strategic) beta realm. Let’s be generous and say that my quote was among the more generic in the story. So I thought I’d take a second to lay out two thoughts based on points within the article.

1. Smart beta WILL be successful

The parade of managers lining up to launch smart beta strategies is a pretty good indication, despite some mixed results in asset gathering. The simple fact though is that there is a sizeable gap between the philosophies of traditional active and passive strategies. There is no reason that strategies that include elements of both shouldn’t be successful as well. The idea that these strategies are solely a marketing gimmick is disingenuous.

If the asset management industry is a (somewhat uneven) barbell with passive at one end and active at the other, I believe the eventual (long-term) outcome is a more evenly-distributed pipe where the middle has significant or even as much traction as the endpoints.

2. Smart beta should align itself with active

To some degree I’ve always felt that the “passive” label for investments is a misnomer. These are still purposeful strategies designed by human beings based on their ideas. So while the day-to-day decision-making on holdings are removed from a portfolio manager, the underlying guidelines remain very much human. These are not robotic strategies divorced from the thoughts of people.

This is even more evident with smart beta strategies, which exist wholly because people think they can improve upon (or at least offer alternatives to) traditional passive. Many smart beta managers regret the prevalence of the word ‘beta’ in the category name; even so, few push to align these strategies explicitly with active. That should (and I believe will) happen more, especially since many of the market entrants are traditional active players. If nothing else, it’s a more accurate way to present what these strategies are.

[ Image courtesy of ValueWalk ]

David Swensen and the Reality of Past Performance

Posted by Mike McLaughlin on Aug 15, 2011, in Thoughts , tagged with , , , , ,

If you read our blog, by now you’ve probably also read David Swensen’s op-ed from the Saturday New York Times. There’s a lot in there worthy of discussion, but one paragraph in particular got a strong reaction from me:

Mutual fund companies, retail brokers and financial advisers aggressively market funds awarded four stars and five stars by Morningstar … But the rating system merely identifies funds that performed well in the past; it provides no help in finding future winners. Nevertheless, investors respond to industry come-ons and load up on the most “stellar” offerings.

Let’s all say it together: past performance is not predictive of future results. True in investing? Yes. In life? No.

The reason David Swensen gets to write an op-ed for the New York Times and lead the Yale endowment is because of what he’s done in the past. Looking at the track record of anything is the most intuitive evaluation barometer we have. Ignoring it is neither natural nor logical.

This doesn’t mean the issue Swensen raises – investors unsuccessfully chasing performance – isn’t real. I just think he’s angrily, unfairly, and incorrectly casting blanket blame on mutual fund marketers and financial advisors, who generally believe in what they’re doing and try to do right by their customers and themselves.

The real enemy here for Swensen is human nature. It’s in our nature to be emotional and overconfident, and compensating for these realities will require a lot more than broad-stroke, ham-handed criticisms of an entire industry.

New Complexity with New Indexes

Posted by Anu Heda on Mar 03, 2011, in Thoughts , tagged with , , ,

Last week, Mike wrote a compelling post about index investing, specifically the complexities and volatility.   I thought that was timely after reading the news that Russell Investments and a partner were creating 24 new indexes based on the Fundamental index methodology.  This method uses adjusted sales, operating cash flow and dividends plus buybacks instead of market capitalization for weighting securities within an index.  It’s a really interesting approach and seems to have numerous merits.

I’m not the right person to discuss the merits of one approach versus the other.  This different approach brought a thought to mind: we should evaluate and scrutinize any backwards looking data closely.  I have some first-hand experience with that.  … [read more]

Does Everyone Really Understand the Complexity of Index Investments?

Posted by Mike McLaughlin on Feb 18, 2011, in Thoughts , tagged with , , , , ,

Third in a series of posts on the sales and marketing implications of the ongoing debate between active and passive management.  Read the first and second posts.

Back the spring of 2009, David Swensen, who oversees Yale’s endowment, gave an interview about his investment principles.  A frequently-repeated quote from the interview is:

With all assets, I recommend that people invest in index funds because they’re transparent, understandable, and low-cost.

The word that jumps out to me is understandable.  I think most investors and financial advisors would reflexively agree that index vehicles are exactly that – a tribute to the way they have been described and marketed.

But there is a variable involved in index investing that makes me wonder if everyone understands index products as well as they believe they do:  the underlying indices.  We spent some time digging into a variety of investment indices, leading us to two conclusions:

  1. Indices are Complex: An index is an easy concept in the abstract, but not so in practice.  For example, to fully digest the methodology behind the creation/maintenance of MSCI indices, you’re going to need to read 119 pages of information.  And consider how different theories have emerged on how indices can be best constructed.

  2. Indices can be Volatile: The components of indices vary regularly, and sometimes significantly.  For example, almost 700 securities were added / removed from the MSCI Small Cap indices at the end of last year.  Even the US Large Cap 300 index had 5% turnover in November 2010.

In addition, index updates sometimes occur as infrequently as every six months.  2008 did a lot to remind everyone how much can change in six months.

In the marketing of investment vehicles, index investments are presented as the simplest, most straightforward option.  As Mr. Swensen stated, they’re understandable.  But as we talk with advisors, they typically get indices conceptually but not in great detail. Data like that presented above catches many by surprise.

For firms positioning themselves and their products against index investments, this represents a way for marketing and sales teams to potentially change the conversation.

The One Question to Ask Passive-Leaning Advisors

Posted by Mike McLaughlin on Jan 26, 2011, in Thoughts , tagged with , , ,

Second in a series of posts on the sales and marketing implications of the ongoing debate between active and passive management.  Read the first here.

A client came to us with an issue – internal wholesalers were repeatedly encountering the same objection when discussing the firm’s emerging markets products with advisors.  The objection:  I use index products for emerging markets exposure.

We suggested a number of ways to address this objection with facts (more on those later this week).  But given the relative inexperience of many internal wholesalers, we suggested that they pose the objecting advisor a simple question:

Do you use actively-managed products anywhere in client portfolios?

Why is this type of question effective?  Two reasons:

  1. If the answer is no, the wholesaler immediately knows that there’s not much point in further engaging the advisor.  No further, unnecessary investment of time by anyone.

  2. In the more-likely scenario where the answer is yes, the wholesaler can open up a conversation on the criteria the advisor uses in evaluating active products.  The discussion becomes advisor-centric, not product-centric, and sets the table for the wholesaler to better position the firm’s products.

So much of the active vs. passive management discussion is one that revolves around analytics and data.  And for good reason.  However, for firms dealing with this discussion in day-to-day field and phone interactions, it’s best to first focus on the client.