Growing up, I was a big fan of the Terminator movies with Arnold Schwarzenegger. Well, the first two at least. The third movie, and the first not directed by James Cameron, was an absolute disaster.
As described by Wikipedia and movie site Fundango, The Terminator is set in a post-apocalyptic 2029, where artificially intelligent machines seek to exterminate what is left of the human race. Schwarzenegger stars as T-800, a humanoid robot from the future. In the first film, Schwarzenegger’s character is sent back to 1984 to kill Sarah Connor (Linda Hamilton), the would-be mother of John Connor, the man who will one day lead the human resistance against the brutal and oppressive robots. However, the humans are able to also send a human resistance fighter, Kyle Reese (Michael Biehn) to protect her. That thesis sets the stage for at least four theatrial relases and one television series lasting close to 25 years.
The original concept that “the machines” sent back a robot to terminate John Connor, the leader of resistance against them, before he is even born is an excellent one. However, the plot is also revolves on the fact that Reese falls in love with Ms. Connor and eventually fathers her baby – the child who ends up being John Connor, the man who sends him in the first place.
As an analytical guy, that one recurring fact always bothered me.
It’s a chicken and egg issue. How could Kyle Reese be the father of John Connor if John Connor of the future is the man who sends him back in the first place? It’s an interesting circular reference, but for the fact that its origin is inexplicable. I’d say it’s inconceivable, but that’s for another blog post altogether.
But I digress. This is a financial blog. What am I doing talking of Terminators? Let me back up.
John Bogle, founder of the Vanguard Group, created the first publicly available index fund. In his senior thesis at Princeton, “Mutual Funds can make no claims to superiority over the Market Averages,” Boogle laid the original thesis for his now Index empire. Boogle wrote later that his inspiration for starting an index fund came from three sources, Paul Samuelson’s 1974, “Challenge to Judgment“, Charles Ellis’ 1975, “The Loser’s Game” (side note, I used to work for Charlie Ellis), and Al Ehrbar’s 1975 Fortune magazine article on indexing.
From that early thesis to today where, according to the Investment Company Institute, of households that owned mutual funds, 33% owned at least one index mutual fund in 2011, and 383 index funds managed total net assets of $1.1 trillion. Equity Index mutual funds represented 16.4% of all equity mutual fund assets at the end of 2011.
There are throngs of investment advisors and pundits, including this author, who have made derogatory remarks regarding active management and active managers. If one searches Google for “passive manaegement beats active management,” he or she will recieve 624,000 results. ETF trends writes in October of last year, “According to the latest data from Standard & Poor’s, most passive index funds, including exchange traded funds, beat out the performance of actively managed mutual funds. There are a few exceptions, but on the whole, active management is not outperforming.” Earlier this year, it was reported by Lipper than only 39% of active managers beat the S&P 500.
However, I pose this question: Much like the Terminator’s John Connor, can Index funds exist without active management? I say no. There is a careful symbiosis that exists between asset managers who partake in different investment styles. We live in a world of mostly efficient markets. However, those markets are efficient because different investors pursue different styles. I can not even imagine a world where all investments were passive. In fact, I’m not even sure it could exist. Value would only grow through money flows, and as such, the finance system would be one big Ponzi scheme.
Active management relies on a thoughtful investment process. One of the biggest problems today for active managers is that many “actively managed” funds are truly closet index funds but nevertheless charge higher fees to the investor. Hedge funds emerged to capture the missed opportunities by traditional active management. Today, one could argue that hedge funds themselves have become too big and too traditional to capture those opportunities. But rest assured, everyone from a stay-at-home, self-directed investor to a professional money manager can have differentiated and market beating returns (otherwise known as Alpha).
You don’t need fancy algorithms. You don’t need higher degrees of math. Just a long-term objective and a tested investment strategy to help you meet those goals. Bloodhound provides you with the opportunity to create investment strategies built on common business sense as you see it, and test those strategies to see if they work. It allows you to search some of the best investment strategies out of our database of over one million pre-calculated. Bloodhound provides a suite of professional-level tools for the construction and management of long-term investment strategies, the portfolios that implement them, and the stocks that go into the portfolios, and reduces your need to develop, maintain or acquire sophisticated research skills. In essense, the system helps you create your own personalized, actively managed mutual fund built for alpha.
Passive management can be great in certain circumstances, but good passive management requires solid active management as a balancing effect to keep the market efficient and productive.