On January 16th John “Jack” Bogle, founder of The Vanguard Group passed away. Jack was a giant in the investment world and made a name for himself as index investing pioneer. Jack believed that investing in efficient, low cost funds was best for the average investor. By using index funds, the idea was to approximate the return of the index instead of hoping to beat it with active management. Overtime his philosophies and advice garnered a cult like following (named the Bogleheads).
This indexing philosophy gained a life of its own and somewhere down the line became a bit twisted. The media now lumps active management in with annuities, reverse mortgages and Donald Trump in their list of least favorite things. Bogle’s passing only seemed to stoke the fires with some outlets even reporting that active management has “gone the way of the dodo”.
So, are the Bogleheads right? Would you be crazy to invest your money with active managers? Would your assets go extinct along with the dodo? Obviously, I am being a facetious but the answer of which is better, along with most other things is… it depends.
A recent study by John Hancock breaks down 20 different asset classes and compares how frequently and to what magnitude active management beats their passive counter parts over 10-year periods starting in 1987. When you look at all funds, it’s almost a dead tie with active management coming out on top eight times, passive coming out on top eight times, and two asset classes that are a wash. Neuberger Berman also did a very similar study (The Overlooked Persistence of Active Outperformance) where they show that if you only look at the top 75% of active funds, they beat their index nine out of ten times. Obviously, this doesn’t really matter if active only managed to outperform marginally, but according to the Hancock study, the outperformance can be upwards of 6% in some asset classes.
Index Funds and ETFs have had a great run after 2008, but during that time there have been some red flags. Over the last few years passive strategies have been rewarding size and momentum, not always the health, growth potential and earnings of a company. This causes the giants like Microsoft, Apple, Amazon and Facebook to receive roughly 12% combined of flows into the S&P 500 funds whether or not they deserve it. Late in the market cycle we feel its better to leave the investment decisions up to the portfolio managers and their teams of analysts versus blinding investing in the broad market.
Ironically enough late last year Jack Bogle pointed out his largest unintended consequence of index investing, which actually has nothing to do with market performance or bubbles. Soon, index funds will own half of all U.S. stocks. Drink that in for a second. This happening not only challenges the historical notions of corporate structure, but potentially leaves a power vacuum in our countries largest companies where index funds control the majority vote.
In the grand scheme of things active and passively managed investments both have their place in investing today. Many consider using a combination of both to be the ideal strategy, but with current market conditions and the around index investing we lean more towards active management.