Note: This article appears on the ETFtrends.com Strategist Channel
By Tyler Denholm, CFA
Some Things Never Change…or Do They?
A popular debate in the asset management industry is “passive” vs. “active” investing. Index-based investment vehicles have gathered a significant amount of assets over the last decade, to the detriment of active investing, perpetuating this debate even further.
While there is a misconception among some in the investing public surrounding the attributes of index-based investing, there is nothing “passive” about managing an index-based portfolio. As such, we tend to dislike using the word “passive” and instead prefer “index”. Not only does tracking the index require skill and resources, but the creation of the index and constant monitoring require experience and astuteness
From the set-up of the portfolio allocation, selection of the underlying investments, to the ongoing monitoring and account maintenance, a lot of time, energy and resources are devoted to these so-called “passive” strategies.
Read the Label Before Digging In
We are constantly bombarded with labels and disclosures in our lives. From the food we eat to the shirt we wear, nearly everything has a label. This often numbs our senses when it comes to certain items. Likewise, we typically don’t understand more than 50% of the ingredients in our breakfast cereal, let alone something more technical. Instead of differentiating through the information on the label, the annoyance and complexity of the label itself often drives us to view things as commodities.
We believe that many investors have this same attitude concerning index investments. With the complexity of the disclosures, investors tend to rely instead on the broad marketing names of the funds. This can be a dangerous strategy.
Remember to Monitor
One area of index-based investing which requires a lot of time is the ongoing monitoring of the underlying indexes. This is a task which many investors do not think much about, but can have a profound impact on their portfolio. Investors often buy a large cap fund that tracks the S&P 500 index fund, for example, and expect it to track the S&P 500 forever. However, what if that large cap index fund switches indexes to the Russell 1000? While not a large change in allocation, it could have impact on other, overlapping holdings in the portfolio.