ITA Wealth Management

In my files, I have a paper titled, “A Comparison of Active and Passive Investment Strategies.” I don’t know the origin of this paper as there is no reference given. I think it was prepared for an investment committee that was in the process of making a decision whether or not to move away from active management and toward a passive investment strategy.

Which Works Best – Active Management or Passive Management?

“Research supporting passive management comes from the nation’s universities and privately funded research centers, not from Wall Street firms, powerful banks, insurance companies, active managers, and other groups with a vested interest in the huge profits available from active management.” We might add CNBC, other financial broadcasts, and financial newsletters into the mix as they are vitally interested in active management.  Investors would be better off if they followed the research rather than the advertising money.

“The results from this research are very clear: Active investment management is an appealing mirage which substantially boosts costs and decreases returns compared to properly designed passive portfolios.”

When we speak of passive and active management, definitions are necessary.  Active management is much easier to define as it is the art and “science” of security selection based on a belief that a manager can consistently predict financial events better than other managers, and as a result, outperform the broad market or a particular benchmark. There is abundant research to show this is a myth.

Passive management is not as easy to define.  The passive management style carries multiple definitions or at least the term is used loosely.  I suspect I’ve fallen into this trap as well over the nearly two years I’ve been writing this blog.  If we define passive investing narrowly, at the very least, it is the antithesis of active management.  That much is clear.  The passive manager recognizes they are unable, through research, brains, clever moves, instinct, and investment software, to outperform their benchmark.  The passive manager recognizes that net of costs, they are unable to “beat the market,” but they can perform better than the majority of active managers.

The passive manager will lay out an investment policy of several asset classes and then populate those asset classes with index funds so as to mirror the policy.  Market timing is out of the question.  Tactical Asset Allocation (TAA) is on the no-no list.  Rebalancing is permitted.

I do not claim to be a pure passive investor.  While I certainly tilt toward passive investing when compared to active investing, I do tilt portfolios toward value vs. growth and toward mid and small-cap size vs. large-cap size. Those moves could be considered active decisions.  In addition, I will sprinkle in an individual stock in larger portfolios.  These are moves a pure passive investor would not do.  The reasons for making these “active” management decisions is to add alpha to the portfolios.  There is research to back these moves and it has paid off over the past 10 to 12 years of detailed record keeping.

I prefer to call the investment style used here at ITA Wealth Management a Mosaic style.  The primary “flavor” is passive with a little “seasoning” of active added in order to enhance the “taste” — that of performing better than the benchmark.

Premium subscription available for $5.00 per month through the next few days.