Much to my chagrin, I’m writing about active versus passive investment management again. While I continue to believe that the behavioural drag on returns is a more attention-worthy problem – because advisers are more able to address it with less conflict of interest – people still train their sights on the dead horse that is the active-passive debate.
In a recent column, I suggested that financial advisers stop hiding behind marketing-speak when defending active management and instead focus on promoting the value they can add with financial planning and reducing the behavioural drag on performance.
The case is clear: The cost drag on performance of active versus passive products might be 2 per cent annualized. The behavioural drag, buying and selling at the wrong time, is closer to 5 per cent with either style. The bigger target is also a cleaner target, as the compensation structure of financial advice provides a massive bias towards active funds in Canadians’ portfolios. Because active products pay more to the average adviser, they will be recommended more often to the average client. That’s also the same reason the industry will continue to defend active management, mostly with bad marketing.
But, after my column I received an e-mail from a reader who agreed with my position but wanted to know if it was true that “no one” had found a way of identifying long-term outperformance in advance. We all know outperformance can be identified in the rear-view mirror, but the value is in identifying it in advance, reliably.
So, I’m putting the call out there. Here’s the a challenge for active-management proponents:
Without relying on faith-based arguments, please provide some support that shows long-term, active management outperformance can be reliably identified in advance.
Preet Banerjee, a personal finance expert, is the host of Million Dollar Neighbourhood on The Oprah Winfrey Network. You can read his blog at WhereDoesAllMyMoneyGo.com and follow him on Twitter at @preetbanerjee.