In my first opinion piece for ETF.com, a leading authority on exchange-traded funds, I took the opportunity to add my voice to a perennial discussion in the investment industry: the active versus passive debate.
Some believe the terms “active” and “passive” describe how frequently an underlying index is rebalanced or active portfolio is managed, whereas others believe it has to do with how active the approach is to risk management. While this debate is interesting from an academic standpoint, I do not believe either side is entirely correct.
For one thing, technology, innovation and competition have changed the active versus passive debate because they’ve reshaped every aspect of trading and investing in the past 15 years. Moreover, rather than jumping straight to active versus passive, investors need to first understand what they want their investments to do, as well as the risk/return trade-off they are willing to accept. Ultimately, this debate should be less about active versus passive, and more about rules-based indexes versus active management. Because of innovations in indexes, asset classes and strategies that fit into a rules-based methodology can be packaged into a product to achieve investors’ goals — the ETF market being a good example.
I appreciate that ETF.com gave me the platform to offer a somewhat different take on a debate that will continue to captivate the investing world. An excerpt of my article is shown below. To read the full piece, please visit ETF.com.
Why Active Vs. Passive Is The Wrong Debate
Like nations that have been in disputes for centuries, the “active versus passive” debate is an issue in the investing world that never seems to go away. While the academic underpinnings of the debate prove interesting — and may last forever–do investors even remember the original issue that started the debate?
There are now markets in virtually every asset class, sector, geography and strategy. Rather than debating “active versus passive,” should investors address the underlying assumption of full market efficiency?
Market efficiency theories seem to be tested every few years, especially after downward plunges in financial markets, a rapid increase in commodity value, or after volatility in illiquid markets in very short time intervals. The questions for investors are, what does “active versus passive” mean to them, and are we debating the same original issue?
Investors have disparate views of the terms “active” and “passive.” While some believe it refers to how frequently the underlying index is rebalanced or active portfolio is managed, others historically have said it has to do with how active the approach is to risk management. Active managers may try to lessen exposure when markets seem to get riskier or have a fundamental view on risk, while indexes remain unchanged. I do not believe either viewpoint is correct today, for a number of reasons.