ITA Wealth Management

Harold Evensky, in his book, “Wealth Management: The Financial Advisor’s Guide to Investing and Managing Client Assets” provides one of the better discussions of passive and active management.  Permit me to quote extensively from this book.

“On the one hand, the arguments in favor of passive management seem far to compelling to ignore.  On the other hand, there are a number of problems associated with passive management (at least from the perspective of the wealth manager) that academic and institutional research do not address.

• There are a very limited number of passive funds available to the wealth manager and these are for a limited number of asset classes.  There is an easy solution to this problem which I will explain later.  Keep in mind Evensky wrote this book in 1997 or before we had all the ETF options.
• Passive funds are designed to track a specific benchmark.  The selection and management of that benchmark may be based on the vendor’s intuition and may change.  Passive funds are not all science; there is plenty of room for art. This potential problem is now solved if one is using the latest edition of the TLH spreadsheet as we do over on the Premium Content side of this blog.
• Similar benchmark descriptions may mask fundamental differences in composition (e.g. whose definition of value).
• Many passive funds have moderate to high turnover and may not be especially tax efficient.  This problem is solved with the advent of ETFs.
• Wealth managers deal with real retail clients.  On of our responsibilities is to make our clients comfortable with their investment portfolio.  At least today, many clients are incapable of being comfortable with an all-passive portfolio.  This is a matter of educating the client.  At least one should move them from active management over to Mosaic management.

Evensky extends this discussion, but you get the concerns he has when it comes to using a totally passive portfolio with a client.  As a wealth manager, Evensky searches for money managers for his clients.  Bullet one above indicates this.  I would counter that it is not necessary to select a manager when the odds are that the manager will not outperform the market or their benchmark.  Why pay a manager to put you in a passive fund that only overlays another set of fees.  Instead, do it yourself and set up your own portfolio using an array of basic asset classes.  Populate those asset classes using index mutual funds or ETF index funds.  My preference is to use ETFs while William Bernstein prefers index mutual funds.  At least that is what I pick up from his writings.

As for active vs. passive portfolio management, my bias is to shift to the passive style.  I’ll expand on the reasons either here or over on Premium.  While I’m not a pure passive investor, as a Mosaic investor I am much closer to following a passive style than I am to taking the active management route.  So far, the results are compelling to continue along this passive road.

Lowell Herr

Photograph:  Otto

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