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Choices

A or B (or some of each)?

For A read alpha and B, beta. No, this isn’t a Greek lesson but what is available to investors today.

B is the passive bandwagon that delivers index performance at low cost and being promoted or shouted from the virtual rooftops today. You can get more specialised beta but that will cost you more.  The argument is that ‘active’ fund managers deliver beta but after costs, deliver less than index performance so why bother with ‘active’ managers?  Pick passives instead and your cost or underperformance is less, is how the argument goes.  Of course, there might be ‘active’ managers that deliver market or index performance for much lower volatility and that might be worth paying an ‘active’ fee for.  Probably not worth the effort though.

The rare but beautiful Flameback Woodpecker. Image Source: Pinterest

Apparently the A or alpha isn’t abundant or according industry academics is akin to a rare bird, seldom seen. Firstly, what is the alpha over? Is it the performance after fees above an index?  Supposedly.  We would ask, is an index an appropriate measurement of an individual investors’ investment objective or outcome? Probably not and probably not one he/she can easily understand.  Whereas references to inflation, surely an investor’s greatest threat are like that rare bird – seldom seen.

’If you want an active manager, choose someone that’s very different from the index. The S&P 500 is not an investment vehicle.’  Both quotes from Dr David M. Blitzer PhD, Managing Director and Chairman of the S&P Dow Jones Index Committee.

If you want beta, buy passives – simple. If you want alpha find a manager not constrained by size and who is index-agnostic.  That means managers that regularly beat index returns because they largely ignore the index constituents and their respective weights, preferring to build a portfolio of conviction with a relatively small number of stocks that they want to own.  I mean, why invest with a manager who says ‘I don’t like XYZ plc but it’s 6% of the index so I only have a 3% weighting’.  Yes, that really does happen and usually sometime after the slide announcing that the asset manager runs £250 billion in assets under manager.  So, too big to deliver what I want then.

Seek and you shall find…

Those genuinely active managers do exist, they can also be spotted by their desire to put the investor’s return above the need to gather assets. To put it another way, putting the investor before the shareholder. You have to search harder, beyond the more obvious larger providers to find them or invest with someone who knows where to look.  You can actually have a mix of active and passive investments.  Consider, with perfect hindsight that you wanted to be in the market in March 2009 as risk markets were turning.  Beta would have been good and reasonably cheap (allowing for pricing anomalies).  Consider, eight years on and in a mature market, beta might need to be tempered.  Find the active manager to deliver.  Being too big might not help large institutional investors but their issues shouldn’t be a hindrance for individual or retail investors.

Right now, A is best, sometimes A and B work together but B by itself looks increasingly risky. Buying what’s gone up might be cheap, it might make you feel good momentarily but when you are the top of the ladder and it begins to wobble, it feels quite uncomfortable.

Image Source: www.sat.dundee.ac.uk