Capital Ideas Blog

Buying stocks is passé

By Chelsea Vail

From: Blog

The Financial Times’ FTfm supplement is always a good read, and the latest issue, dedicated to passive investing, was particularly “cut out and keep”-worthy.

Some nuggets:

  • Two-thirds of mutual fund professionals have a meaningful amount of their personal investments managed passively (see Danielle Sottosanti’s report on why they’re selling active and buying passive)
Of course, the virtues of passive investing are not breaking news. Chicago Booth Professor Eugene Fama started making the case for it more than four decades ago. He also published a paper in 2010 that found the average return for active fund managers was slightly negative (at -.18 percent annually from 1984-2006).

Fama recently delivered more bad news for active investors, telling Reuters columnist John Wasik that a return of 1 percent above a broad market index is considered above average. Only the very best active funds can outperform the market when fees are included.

It looks like the active fund business has some explaining to do, but apart from dissatisfaction with returns, what accounts for the mass exodus of investors? Why now? Walker argues that the rise of ETFs has sparked investor interest in passive investing.

Passive funds also have a psychological advantage over active funds, research finds. A recent study by Tom Chang and David H. Solomon at the University of Southern California and Mark M. Westerfield at the University of Washington found that investors are harder on active managers than passive ones when products perform poorly.

Investors who get burned by their active managers are more likely to take their money elsewhere—often to firms with low fees such as Vanguard. (In FTfm, Jackie Noblett reports on Vanguard’s success in its recent move to benchmarking with Booth’s Center for Research in Security Prices (CRSP) indices.)

It’s hard to beat the market, and it’s hard to watch your savings being mismanaged. So have you fired your active manager yet?


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