2  Active Management

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2.1 High Fees

📖 Actively managed funds typically have higher fees than passively managed funds

2.1.1 High fees can eat into returns, especially over the long term.

• Belief:
  • Actively managed funds often underperform their benchmarks, and the high fees they charge can compound the problem.
• Rationale:
  • The average expense ratio for actively managed funds is 1.2%, while the average expense ratio for passively managed funds is 0.1%. This difference may seem small, but it can add up over time. For example, if you invest $100,000 in an actively managed fund with a 1.2% expense ratio, you will pay$1,200 in fees over the first year. If the fund underperforms its benchmark by 1% per year, you will lose $1,000 in investment returns. This means that you will actually lose money in this investment, even if the market goes up.
• Prominent Proponents:
  • John Bogle, founder of Vanguard
• Counterpoint:
  • Some investors believe that the higher fees charged by actively managed funds are worth the cost if the fund can outperform its benchmark. However, there is no guarantee that an actively managed fund will outperform its benchmark, and even if it does, the outperformance may not be enough to offset the higher fees.

2.1.2 High fees can discourage investors from saving and investing.

• Belief:
  • When investors see that a significant portion of their returns are going to fees, they may be less likely to save and invest.
• Rationale:
  • Fees can eat into investment returns, especially for small investors. For example, if an investor with a $10,000 portfolio pays a 1% annual fee, they will lose$100 per year. This may not seem like much, but it can add up over time. If the investor keeps their money in the investment for 20 years, they will lose $2,000 in fees.
• Prominent Proponents:
  • Warren Buffett, CEO of Berkshire Hathaway
• Counterpoint:
  • Some investors believe that the benefits of actively managed funds, such as the potential for outperformance, outweigh the costs.

2.1.3 High fees can create a conflict of interest between investment managers and their clients.

• Belief:
  • Investment managers who charge high fees may be more likely to recommend investments that are not in their clients’ best interests.
• Rationale:
  • Investment managers are paid to manage money, and the more money they manage, the more fees they earn. This can create a conflict of interest, as investment managers may be more likely to recommend investments that generate high fees, even if those investments are not in their clients’ best interests.
• Prominent Proponents:
  • The Securities and Exchange Commission (SEC)
• Counterpoint:
  • Some investment managers argue that they are able to provide valuable services to their clients, and that their fees are justified.

2.2 Underperformance

📖 Active management often underperforms passive management over the long term

2.2.1 The indexing revolution has been one of the great investment success stories of the past few decades.

• Belief:
  • Indexing is a simple and effective way to invest in the stock market.
• Rationale:
  • Index funds track the performance of a specific market index, such as the S&P 500 or the FTSE 100. This means that they provide investors with exposure to a broad range of stocks, which reduces risk compared to investing in individual stocks.
• Prominent Proponents:
  • John Bogle, founder of Vanguard
• Counterpoint:
  • Active management can outperform indexing in certain market conditions.

2.2.2 Active management is a more sophisticated investment approach than indexing.

• Belief:
  • Active managers use their expertise to select stocks that they believe will outperform the market.
• Rationale:
  • Active managers have the ability to make changes to their portfolios more quickly than index funds, which can give them an advantage in volatile markets. They can also take advantage of market inefficiencies to find undervalued stocks.
• Prominent Proponents:
  • Warren Buffett
• Counterpoint:
  • Active management can be more expensive than indexing.

2.2.3 The best investment strategy depends on your individual circumstances.

• Belief:
  • There is no one-size-fits-all investment strategy.
• Rationale:
  • The best investment strategy for you will depend on your risk tolerance, investment goals, and time horizon. If you are not comfortable with the volatility of the stock market, then indexing may be a better option for you. If you are looking for the potential to generate higher returns, then active management may be a better option.
• Prominent Proponents:
  • William Bernstein
• Counterpoint:
  • There is evidence to suggest that indexing is the better long-term investment strategy.

2.3 Complexity

📖 Active management is more complex than passive management, which makes it more difficult to understand and implement

2.3.1 Complexity is a Barrier to Entry

• Belief:
  • Active management is complex and difficult to understand, which makes it challenging for investors to implement effectively.
• Rationale:
  • Active management involves making complex investment decisions, analyzing market data, and managing portfolios, all of which require a high level of financial expertise and knowledge.
• Prominent Proponents:
  • John Bogle, founder of The Vanguard Group
• Counterpoint:
  • While active management can be complex, there are resources available to help investors understand and implement active strategies, such as financial advisors, investment books, and online courses.

2.3.2 Complexity Adds Value

• Belief:
  • The complexity of active management allows investors to tailor their portfolios to their specific goals and risk tolerance, potentially leading to better returns.
• Rationale:
  • Active managers have the flexibility to make unique investment decisions based on their research and analysis, which can lead to outperformance compared to passive strategies.
• Prominent Proponents:
  • Warren Buffett, CEO of Berkshire Hathaway
• Counterpoint:
  • The complexity of active management can also lead to increased costs and reduced transparency, which may not always justify the potential benefits.

2.3.3 Complexity Hinders Scalability

• Belief:
  • The complexity of active management makes it difficult to scale and implement on a large scale, limiting its accessibility to smaller investors.
• Rationale:
  • Active management requires a significant amount of time and resources to research, analyze, and manage portfolios, which can be challenging for smaller investors with limited resources.
• Prominent Proponents:
  • Jack Bogle, founder of The Vanguard Group
• Counterpoint:
  • While active management can be complex, there are now a range of actively managed ETFs and mutual funds available, making it more accessible to a wider range of investors.

2.4 Lack of Transparency

📖 Active managers often do not disclose their investment strategies, which makes it difficult to evaluate their performance

2.4.1 Transparency is essential for investors to make informed decisions.

• Belief:
  • Investors need to know what they are investing in and how their money is being managed.
• Rationale:
  • Without transparency, investors cannot properly evaluate the risks and returns of an investment.
• Prominent Proponents:
  • Warren Buffett, Charlie Munger
• Counterpoint:
  • Some active managers argue that disclosing their investment strategies would give their competitors an advantage.

2.4.2 Lack of transparency can lead to conflicts of interest.

• Belief:
  • Active managers may be tempted to make investment decisions that benefit themselves rather than their investors.
• Rationale:
  • Without transparency, investors cannot monitor the actions of active managers and ensure that they are acting in their best interests.
• Prominent Proponents:
  • The Securities and Exchange Commission (SEC), the Financial Industry Regulatory Authority (FINRA)
• Counterpoint:
  • Active managers argue that they need to maintain some level of secrecy to protect their intellectual property.

2.4.3 Transparency promotes accountability.

• Belief:
  • Active managers should be held accountable for their investment decisions.
• Rationale:
  • Transparency allows investors to hold active managers accountable for their performance.
• Prominent Proponents:
  • John Bogle, the founder of Vanguard
• Counterpoint:
  • Active managers argue that they should not be held accountable for short-term performance.

2.5 Risk

📖 Active management can be more risky than passive management, as it involves making more frequent trades

2.5.1 Increased Risk

• Belief:
  • Active management involves more frequent trading, which increases the risk of losses.
• Rationale:
  • Frequent trading can lead to higher transaction costs and potential losses if the market moves against the investor’s positions. Additionally, active managers may make more speculative investments in an attempt to generate higher returns, which can further increase risk.
• Prominent Proponents:
  • John Bogle, founder of Vanguard
• Counterpoint:
  • Active management can also mitigate risk by allowing investors to adjust their portfolios more quickly in response to market conditions.

2.5.2 Reduced Diversification

• Belief:
  • Active management typically involves investing in a smaller universe of stocks than passive management, which reduces diversification.
• Rationale:
  • Active managers may focus on specific sectors or industries in an attempt to outperform the market, which can lead to concentration risk if those sectors or industries perform poorly. Passive management, on the other hand, provides diversification by investing in a broad market index.
• Prominent Proponents:
  • David Swensen, former Chief Investment Officer of Yale University
• Counterpoint:
  • Active management can allow investors to customize their portfolios to meet their specific risk and return objectives.