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In portfolio management, there is an ongoing, and seemingly never-ending, debate about whether passive investing or active investing is more efficient and profitable.
Passive investing can be traced back to August 31, 1976, when Jack Bogle launched the Vanguard 500, the First Index Investment Trust. The product quickly attracted much derision from traditional stock pickers for its central premise that buying and simply holding the broad stock market would provide better results than trying to beat it by picking stocks day in and day out. This premise is the central thesis of passive investing.
Over the course of the last 40 years, this investment thesis has become increasingly recognised and adopted, and the rise of index funds and Exchange Traded Funds (ETFs) has taken passive investing to the mainstream. In the US market alone, as of the end of 2017, there is more than $4.2 trillion USD managed by 1,800+ US listed ETFs that passively track a variety of different asset classes, from equities to bonds to gold and real estate, and much, much more. In 2016, out of the 15 most traded securities in US markets, 14 were ETFs (the odd one was Apple shares!).
According to SPIVA, over the last 15 years 92.33% of US large-cap managers, 94.81% of US mid-cap managers, and 95.73% of US small-cap managers underperformed their relevant index. In short: only 1 in 20 active managers made more money than the index. Jack Bogle was proven right after all!
Historically, active managers have made money by developing a point of view about a given security before the rest of the market did. Imagine 20 years ago, when financial statements were sent by post (yes, actual snail mail), and the largest managers would receive them first and then have more resources to crunch the numbers. This was a real advantage, and making higher returns than other managers was easy for the best people on Wall Street.
Connections also mattered more back then: regulation were not as stringent, and whispers from CFOs and CEOs helped the more-connected fund managers get the “facts” before others, and take winning positions. As access to information became easier, and regulators became stricter in ensuring market transparency, the job of stock pickers became much more difficult and more because the new environment kept them more honest.
However, active managers have better odds of creating value compared to passive managers in more intransparent markets: in the last 5 years, 1 in 5 Brazil-focused active fund managers and 1 in 2 India-focused active fund managers have outperformed their relevant indices. Still not great, but better than 1 in 20!
StashAway recognises that data has proven that securities selection has not been paying for itself over the last decade, particularly in the largest, most transparent markets. In this respect, StashAway is a convinced passive investor when it comes to securities selection, in that we don’t spend money and time with securities selection, but rather invests through ETFs in the entire “market”.
But in reality, there is not one single “market”; there are many of them. There are equity and bond markets; there are developed and emerging markets; there are corporate and government security issuers; and so on. StashAway’s investment framework takes an active approach in deciding in which market to invest, and in which proportion. This is what is called asset allocation.
This approach is quite common in sophisticated, institutional investors. The paper “Determinants of Portfolio Performance” published in 1986 by the Financial Analysts Journal concluded that asset allocation is the primary driver of a portfolio’s return variability for broadly diversified portfolios. In short, there is significant value to be created through dynamic portfolio management.
We recognise that 80% of returns are driven by asset allocation: determining which mix of assets would best perform in the current economic and market conditions. We intelligently and systematically determine the allocation of assets in a portfolio, with a dynamic approach, by continuously monitoring macro and market data.