A new hit on active investing

Market Analyze

(MoneyWatch) While I never thought I'd see the day, last week's Investment News cover story called into question the viability of active investing. This weekly publication for financial advisers noted that the California Public Retirement System (CalPERS) was considering dropping active managers from the $255 billion fund. Currently about half of this fund is invested using active managers with the other half using passive.

The article states that a mere decade ago, only 14% of mutual funds and ETFs were in passive strategies. Today that amount has doubled to 28% as investors left active and funds flowed into passive. If this doubles again in the next decade, active investing will be a minority. According to Morningstar, only nine percent of large cap mutual funds bested the S&P 500 over a ten, five, and three year period.

CalPERS is expected to decide the fate of active managers for its fund in about five months. Interesting that Chris McIsaac, managing director of the institutional investor group at Vanguard, was quoted in the piece saying he wasn't ready to write off active management altogether. He stated that there will come a time when active managers will do much better, but that the good ones must also have low costs.

My take

A decade ago, I was too busy defending why passive investing wasn't dead to even consider whether active investing would survive. This is absolutely the triumph of indexing that John C. Bogle brought to the public, and is a really good thing.

I am skeptical that active managers will ever have their day. By simple arithmetic, they must always earn the market before fees. This means that owning the entire market at the lowest fee will always beat active overall.

I would be terribly worried if there was any real possibility that active investing was dying, as it is active investing that keeps markets efficient. But I'm not worried, because less than ten percent of the market could be active and still keep markets working. Fortunately, human greed and Wall Street marketing would never let that happen. There are plenty of people willing to buy into the active fantasy. 

Maybe we should declare a national holiday to thank the active traders and money managers that keep the market going. They are the ones that give us a free ride. Long live active investing!

Author's note:  After publishing, I received the following email from CalPERS:

Despite several recent and inaccurate articles, CalPERS has no plans to make a decision about active managers at this time.  This issue arose out of a recent 'Investment Beliefs Workshop' and took the form of a stakeholder presentation to the CalPERS Board.  It was the first of a yearlong discussion to develop the System's Investment Beliefs and Strategic Asset Allocation.  It was not an action item to decide the management of the portfolio. While the debate around active v. passive came up and may continue to take place in this exercise, the adoption of a final set of beliefs later this year will not include investment decisions to change the management of assets. 
Joe DeAnda  |  Information Officer II  |  CalPERS Office of Public Affairs

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    Allan S. Roth is the founder of Wealth Logic, an hourly based financial planning and investment advisory firm that advises clients with portfolios ranging from $10,000 to over $50 million. The author of How a Second Grader Beats Wall Street, Roth teaches investments and behavioral finance at the University of Denver and is a frequent speaker. He is required by law to note that his columns are not meant as specific investment advice, since any advice of that sort would need to take into account such things as each reader's willingness and need to take risk. His columns will specifically avoid the foolishness of predicting the next hot stock or what the stock market will do next month.