Tren Griffin has a terrific blog post on the active passive debate that focuses on the subject from Charlie Munger’s perspective (Griffin is working on a book about Munger).
The general tone of the post was that active management is difficult, most will fail at it (will address failure in a moment), it relies on finding assets that are truly mispriced and it requires a skill set to find truly mispriced equities that most people don’t have and proper diversification comes with far fewer holdings than many people believe.
A couple of great quotes in there include a pretty famous one by Munger where he places great importance on not being stupid. Another one was” being a successful active investor requires a massive amount of time and work. If you don’t enjoy it, why do it?” There was also this; if you are not a passive investor, you must beat the market after fees and expenses. The point being don’t bother if you’re not beating the market.
There’s a lot of ground to cover here. It’s not that I necessarily disagree with the article (a couple of points I do disagree with which we’ll get to) but the real world is much broader than the ground covered in the article.
The definition of active investing can include owning anything beyond a total stock market fund and total bond market fund. There is even an argument that rebalancing between a total stock market fund and total bond market fund is active management.
Actively managing a portfolio is difficult because of the work involved. Some amount of time needs to be spent on each holding (this varies from holding to holding and investor to investor). There is also a knowledge base required to do the work.
Finding (or more correctly looking for) mispriced securities and buying them is certainly one form of active management but there are many others. There are trading strategies that actively use broad based passive ETFs in various trend following or momentum techniques; active management with passive funds. Like any active strategy some number will beat the market and some number will lag the market. And there are countless other forms of active management that don’t solely rely on mispriced securities.
The idea of failing can mean anything but what it all boils down to for most individuals including clients of financial professionals is whether or not they have enough when they need it which is an ongoing theme here. It doesn’t do anyone much good to say they beat the market over the course of their investing career if they are 80, healthy and out of money. It is difficult to describe a long term strategy (active or passive) that results in having enough when you need it as being a failure.
As a middle ground, if we think of a passive strategy as owning broad based index funds then the result will track those indexes less what should be a pretty low expense ratio.