Active vs passive, process, Bernie Madoff and private equity - the best investing blogs and podcasts from the past week
When it comes to cognitive dissonance - when what you believe doesn’t match up with what you actually do - the idea of an active fund manager investing all their own money in passive funds is a pretty striking example.
Yet that was one of several eye-catching admissions in a set of interviews with fund managers in a recent research study by King’s College London.
I came across this via Barry Ritholtz (here), who in turn got it from Robin Powell at The Evidence Based Investor blog (here). Robin has written a lot on this, so I won’t repeat it all (you can find the full study in this post). But the thrust of the research is really that the massive shift in money flows from active to passive funds in recent years has left at least some active managers wondering what their role is in the world.
The active/passive debate has been rumbling on for a long time. But one accepted truth is that the high fees charged by active managers in search of alpha have been a hugely debilitating drag on performance.
That very simple argument - that fees often cripple returns - has been used to devastating effect by marketing teams in the passive indexing industry. In turn, the bull run for markets since the financial crisis 13 years ago has been an ideal backdrop for them. It has been a period that suited index funds down to the ground - with markets flying, you couldn’t go wrong.
As a result, time and time again you see surveys showing that low-cost indexers beat active stock pickers. This fun little examination by AJ Bell says it all: The best and worst investment strategies of the last 10 years revealed. Over a decade, passive has outperformed active. Even last year, when markets were tumbling, the average passive fund beat the average active fund.
But could this all change now we’re in an environment of higher rates and recessionary forces? If markets become less amenable, will the pendulum swing back in this debate?
There was a post this week by Vitaliy Katsenelson at Contrarian Edge discussing this question. As he puts it: “Investors who own index funds have likely strapped themselves into a giant stock market roller coaster which, to this point, has only gone up.”
You can find that article here: Stock Market Roller Coaster: Prepare for a Decade or Two of Disappointing Returns! (but you’ll need to sign up to read it all)
Perhaps he’s right. If he is, then it’s possible that passive investors will have to get used to more ho-hum returns from here. And the industry will see fund flows start to fall.
But as tempting as it might be for active stock-pickers to start presaging a change of fortune for passive investors, it’s still the case that the active fund industry has a heritage of underperforming its own benchmarks stretching back way longer than a decade - in good times and bad.
Whatever happens, I think such a long spell of the wind in its sails has given the indexing industry time to establish itself as a “sensible option” for many. If markets do start to test the will of investors, simplicity and low cost could play a big role in keeping them committed (rather than spooked out of the market). That will give active managers even more reason to question the value they’re delivering.
Have a great weekend,
Ben
PS. Check below to find all the highlights and posts that have caught my eye this week on strategy, markets and institutional research…
Highlights from the past week
Behavioural Investment - Why Can’t We Stop Changing Our Investment Process?
It’s hard to read this without a flush of guilt that I’ve trampled into some of these behavioural mistakes recently. Changing a strategy, and perhaps even completely changing your investment approach, just seems to trigger an avalanche of possible pitfalls. From recency bias, overconfidence and perhaps even action bias (don’t just sit there, do something) - messing with a solid approach can be a mistake. That said, knowing these possible errors is half-way to avoiding them (I’d like to think). And as Joe says, evolving a strategy for the right reasons is no bad thing.
A Long Time in Finance - [Podcast] Bernie Madoff, The Monster of Wall Street (26 minutes)
Bernie Madoff made Charles Ponzi look like an amateur, with a scheme that was an order of magnitude larger and far longer lasting than anything that went before it. With a Netflix series on Madoff out at the moment, this short podcast from Jonathan Ford and Neil Collins (and guest Dan Davies), takes a whirlwind tour of Madoff and his legitimate-business-turned-bad. It’s reckoned that his fee-free smoke-and-mirrors hedge fund sideline was something he was doing from the start - making it a decades long con. This is a great look back at the story.
Also worth mentioning is the final part in a series of short podcasts from A Long Time in Finance, this time focusing on Bernie Cornfield (who died in 1995). Cornfield was a controversial figure in finance and an excellent salesman (and manager) of mutual funds (and fund of funds). The trouble of course, was that while he did well out of it, most of his unwary investors didn’t. Having lost a ton of money he was lucky to escape justice but didn’t leave much of an impressive legacy. You can find that here: Long Time Short: Bernie Cornfeld's Sincere Desire to be Rich (~10 minutes)
Find all the recent Long Time Short episodes here
Masters in Business - [Podcast] Steven Klinsky on Building Businesses (~1hr)
Back in the late 1990s I was covering deals as a rookie corporate finance journalist. For a short time that meant writing about acquisitions and takeovers. Then came a flood of public market IPOs and fund raisings as the dotcom boom took off. When that died down, private equity was the focus: with VCs and PE firms casting themselves as the answer to some kind of funding gap for SMEs.
Anyway, Steven Klinsky is a legend in PE. He was really one of the early pioneers, and happened to be on the right side in the notorious $24 billion leveraged buyout of RJR Nabisco in 1988. He’s the co-founder and CEO of a huge firm called New Mountain Capital, and this is a really interesting tour through recent history and his views on PE, which is once again enchanting investors.
The transcript of the interview can be found here.
Aswath Damodaran, Musings on Markets - Data Update 1 for 2023: Setting the table! and Data Update 2 for 2023: A Rocky Year for Equities!
A couple of things here. Aswath is a US finance professor and a lot of what he puts on his website has an academic flavour. In the first post he goes over some basics about how he uses market data. He also introduces quite a sizeable expansion of the data that he keeps available, which now includes global securities. The second post is the first (with more to come) that looks back on the performance of markets last year and some calculations on what might lie in store.
Thinking & Strategy
Of Dollars And Data
The 13 Best Movies About Wall Street
Meb Faber Show Podcast
J.P. Morgan's Dr. David Kelly on Why He Believes Foreign Stocks Are Attractive, Inflation Will Subside, & The Debt Ceiling is a "Doomsday Machine" | #463
Joachim Klement
Equal weighting works, but why?
The Acquirer's Multiple
[Podcast] VALUE: After Hours (S05 E2): 2022 Year in Review, The Inner Game, Value Spreads And The 3/10 Inversion
Institutional Research
Finominal
What Are Growth Stocks?
Alpha Architect
Mitigating Risks with Factor Strategies
Premier Miton
Every little helps? How consumers feeling the squeeze creates a trend shift for UK companies
Liontrust
The renaissance of the UK stock market
Verdad
Dot-Com Redux - How to invest after valuation risk strikes
Securities & Markets
Twin Petes Investing
Podcast no.93 with LIVE in person video
AJ Bell Money & Markets
[Podcast] Soaring Government debt, Netflix update, and how to find an index
Investors' Chronicle
[Podcast] The Companies and Markets show: Pubs, QT, and the big tech jobs cull
UK Dividend Stocks Blog
My FTSE 250 CAPE Valuation and Forecast for 2023
Quality Share Surfer
Portfolio Review: January 2023
Money Makers
Weekly Investment Trust Podcast with Jonathan Davis (21 Jan 2023)
Quality Small Caps[Podcast]
Small Caps Podcast with Paul Scott – Episode 3 for 2023