It’s one of the ironies of active asset management that its perceived strength is also its biggest weakness.
To quote Crispin Odey, the billionaire hedge fund manager who somehow managed to lose half his clients’ money in 2016, passive investing is “mindless”. Active managers, on the other hand, have the power to act — to use their skill and expertise to buy and sell and take positions; the power, in other words, to trade securities as and when they please.
But let’s think about trading for a moment. Whereas, in the past, a large proportion of traders were non-professionals, nowadays around 95% of trading is done by professional asset managers. They’re generally all very bright and are all acting on more or less exactly the same information.
Remember, for every trade there’s a buyer and a seller, and for every winner there has to be a loser. So, your fund manager is directly competing with my fund manager. And what makes you think that your fund manager is any smarter than mine?
But that’s just part of the story. It would be bad enough if active management were a zero-sum game. In fact it’s a negative-sum game. Why? For two reasons. First, your manager charges you a fee for managing your money, which over time compounds into a very large sum of money. Secondly, every time your manager places a trade, there’s a long line of intermediaries waiting to be paid. And who do you think pays? You do.
Vanguard Jack Bogle has long warned about the dangers of overtrading. In a recent interview with Business Insider he says:
“The trading is the investor’s enemy. The more that you trade, the worse your performance. It’s been proved over and over again.”
Asked, in the same interview, about the need for active managers to reduce their fees and charges, Bogle responds:
“It’s not (just) the expense ratios that have to be cut, but also the trading. The transaction costs are very high – they’re hidden; they’re not going to tell you what they are – they are there and they are large.”
So, next time you read about the “flexibility” of active managers to trade whenever they want to, perhaps in an advert or an article in the weekend money pages, remember that it comes at a considerable price to you. When you can guarantee, near enough, the market return, at a fraction of the cost, through indexing, it makes you wonder whether it’s active investors who really are the “mindless” ones.
You can read Jack Bogle’s interview with Business Insider here: