Many investors are unaware of the competing philosophies regarding portfolio and fund management. One is known as active investing, and the other is called passive investing. However, there is a third approach called structured investing. It is important for investors to understand the differences between them so that they can make informed decisions about which style of investing works best and the evidence that supports each method.
Active investing is when an investor, professional money manager or team of professionals actively manages a portfolio–they decide about the assets in it and keep track of its performance. The goal of any active investment strategy is to outperform the market and to beat a stated benchmark. This typically involves stock picking and high turnover that can result in higher costs for the investor.
Passive investing is when an investor or team of professionals invests in a fund that tracks an index. The goal of passive investors is to match the performance of the market, not beat it. This style of investing usually involves lower turnover and lower costs for the investor.
Structured investing relies heavily on history and Nobel Prize winning economic theory to structure portfolios around risk vs. return metrics. This philosophy accepts that market timing is a losers game, and in turn tries to maximize returns by being more efficient and focusing on higher expected returns in the market.
Today we’ll cover both active and passive investing methodologies and discuss the advantages and disadvantages of each. We’ll also give you an alternative investing strategy that uses history and financial science as a guide to investing.
Are Markets Inefficient or Efficient?
The debate about whether markets are inefficient or efficient is one that has been going on for years. The concept of efficient markets means that all available information is reflected in the prices of the securities being traded. Efficient market hypothesis (EMH) was first introduced by economist Eugene Fama in his Ph.D thesis in 1965 and later expanded upon by others, including Burton Malkiel in his book A Random Walk Down Wall Street.
EMH states that if markets are efficient, then it’s impossible to “beat the market.” This means that active investors should not expect to outperform index funds over the long term. In contrast, the concept of inefficient markets suggests that there is an opportunity for investors to identify securities with mis-priced risk and return characteristics.
EMH also states that, because markets are efficient, it is not possible to outperform with consistency the market because any information advantage will be quickly incorporated into prices. This means that active investors cannot identify mis-priced securities and exploit them for profit.
Active Managers who believe the market is inefficient will try to outsmart the market by identifying mis-priced securities and exploiting them for profit. However, this is difficult to do because the market is constantly adapting itself in response to new information. History proves that very few (if any) active investors can consistently outperform the market over extended periods of time.
The Proof is in the Pudding – the Evidence
There is evidence that supports passive investing and the Efficient Markets Hypothesis. These studies have been going on for the last fifty years. An ongoing study by SPIVA (S&P Indices Versus Active) compares the performance of actively managed funds to relative benchmarks. SPIVA explores whether active fund managers outperform their benchmarks and if their outperformance is attributed to skill or luck. If there is skill, there would be persistence in the active fund manager’s outperformance of the index.
The study has found that there is no persistence in active fund managers’ outperformance of their benchmarks. The study shows that, over time, active managers will underperform relative benchmarks across all categories: large cap value, small cap growth, etc. There are many other studies that have been done over the years which support this hypothesis as well.
As of June 2022, in a fifteen-year period, close to 90% of large-cap fund managers underperformed the S&P 500 index. This underperformance was close to the same percentage in three, five, and ten-year periods. The underperformance was not only in the large cap category but also persisted across all other fund management styles.
To read more about SPIVA research, visit the link here.
A Scientific Approach – Structured Investing
The debate regarding the best approach to investing will continue in the future. Knowing the evidence will help any investor determine the most prudent strategy and one that will give them the highest statistical probability of success.
A strategy that has worked is called structured investing which uses history and other risk/return metrics to structure a portfolio in such a way that is not active in nature, but also not passive. Certain factors have been shown throughout history to perform better during long periods of time. Examples include stocks outperform bonds, value stocks outperform growth, and small cap companies tend to outperform large cap companies over long periods of time.
According to Dimensional Fund Advisors, “As market prices change every day, a strategy that rebalances only once or twice a year, like most index funds, can leave returns on the table. Dimensional’s flexible process helps us keep strategies continuously focused on higher expected returns while balancing costs and diversification daily. We work for the slightest gain, as every incremental improvement adds up over time.”
This style of investing is not “betting the farm” on one single stock or asset class but takes the passive indexing approach and adds layers of financial science to seek higher expected returns throughout the portfolio.
Next week we will discuss in more detail structured investing and certain factors that may offer benefits to long term investors. This structured approach to portfolio management eliminates the need for stock picking, sector selection, or market timing by targeting specific dimensions of risk and return that can help an investor meet their goals with confidence.
Have a great weekend!
Source: Ballentine Capital Advisors
Golf Tip of the Week
1 Crucial Mistake That Turns Good Rounds Into Bad Rounds—And How To Avoid It
Take a moment, right now, and visualize you playing a good round of golf.
Your career-best round, even. What does it look like?
If you’re like me, you’re probably seeing yourself ripping drives down the middle of the fairway, flagging your irons and dropping putts from all over the place. But it’s quite funny, but when you see a good round of golf being played, that’s not what happens. I was reminded of this the other day, re-watching the highlights of Jordan Spieth’s win from the RBC Heritage earlier this year, as one does.
Around a tight, tricky golf course, Spieth shot four rounds in the 60s en-route to a 13-under total and subsequent playoff victory. Yet in the video below, you’ll notice some bad shots. A few end up in the trees, among other questionable spots.
It’s a solid reminder: Good rounds aren’t made with good golf shots.
So, what are good rounds made of? That’s something our friends at Arccos have studied. They looked at their database of 5-handicap golfers, and what they look like when they shot 75, compared to what they do when they shot 85.
What’s different? A few things.
You DON’T need to make more birdies
In the 10-shot difference between a 5-handicap shooting 75 and 85, only about a shot-and-a-half is made up by making more birdies. It underlines the first, and most important point: If you want to shoot lower scores, it’s not about making more birdies.
Why? Because put simply, golf is really hard, and you’re never going to make enough birdies to make up for the bogeys and doubles. Pro golfers, after all, only make about four birdies per round.
You DO need to avoid big numbers
Think about bogeys like calories. They’re a fact of life, but when you’re trying to lose weight, it’s virtually impossible for most of us to burn off huge amounts of calories from exercising. Instead, you’re better off not eating all those calories in the first place.
And that’s the mistake that turns good rounds into bad rounds: Those 5 handicaps, when they shoot 85, make three more bogeys and two more double bogeys or worse. It’s those double bogeys and other big numbers that wreck your scorecard and make it effectively impossible to come back from.
So, if you’re trying to shoot lower scores, you’ll suck less by doing the simple stuff well: Keeping your ball in play off the tee, avoiding disaster shots around the greens, and making your short putts.
Tip adapted from golfdigest.comi
Recipe of the Week
White Christmas Margarita
- 1 1/2 cups frozen cranberries
- 1 cup tequila blanco
- 2/3 cup fresh lime juice (from about 6 limes), plus 4 lime slices, for serving
- 6 tablespoons orange-flavored liqueur, such as triple sec
- 3 tablespoons unsweetened coconut milk
- 3 tablespoons superfine sugar
- 1/2 cup light corn syrup
- 2 tablespoons extra-fine shredded unsweetened coconut
- Kosher salt
- Divide the cranberries among the sections of a standard (12-cube) ice cube tray. Fill the tray sections with water and freeze until frozen, at least 4 hours and up to overnight.
- Add 1/2 cup of the tequila, 1/3 cup of the lime juice, 3 tablespoons of the orange liqueur, 1 1/2 tablespoons of the coconut milk and 1 tablespoon of the superfine sugar to a large cocktail shaker. Fill with plain ice cubes and shake vigorously until well mixed and very cold.
- Pour the corn syrup onto a small shallow plate. Mix 1 tablespoon of the superfine sugar with the shredded coconut and 1 tablespoon salt on another shallow plate. Dip the rim of a margarita (or other wide-mouth) glass in the corn syrup, then dip the rim in the sugar mixture until well coated. Repeat with 3 more glasses. Pour the shaken margarita mixture into 2 of the prepared glasses. Add 3 of the cranberry ice cubes to each and garnish with a single lime slice.
- Repeat with the remaining cocktail ingredients, dividing it between the remaining 2 prepared glasses and adding 3 cranberry ice cubes and a lime slice to each.
Recipe adapted from foodnetwork.comii
Health Tip of the Week
Why Sitting Too Much Is Bad For Your Health
It hurts your heart
Scientists first noticed something was up in a study that compared two similar groups: transit drivers, who sit most of the day, and conductors or guards, who don’t. Though their diets and lifestyles were a lot alike, those that sat were about twice as likely to get heart disease as those that stood.
It can shorten your life
You’re more likely to die earlier from any cause if you sit for long stretches at a time. It doesn’t help if you exercise every day or not. Of course, that’s no excuse to skip the gym. If you do that, your time may be even shorter.
Dementia is more likely
If you sit too much, your brain could look just like that of someone with dementia. Sitting also raises your risk of heart disease, diabetes, stroke, high blood pressure, and high cholesterol, which all play a role in the condition. Moving throughout the day can help even more than exercise to lower your risk of all these health problems.
You’ll undo all that exercise
The effects of too much sitting are hard to counter with exercise. Even if you work out 7 hours a week — far more than the suggested 2-3 hours — you can’t reverse the effects of sitting 7 hours at a time. Don’t throw away all that hard work at the gym by hitting the couch for the rest of the day. Keep moving!
Your adds of diabetes rise
Yup, you’re more likely to have it, too, if you sit all day. And it isn’t only because you burn fewer calories. It’s the actual sitting that seems to do it. It isn’t clear why, but doctors think sitting may change the way your body reacts to insulin, the hormone that helps it burn sugar and carbs for energy.
You could get DVT
Deep vein thrombosis (DVT) is a clot that forms in your leg, often because you sit still for too long. It can be serious if the clot breaks free and lodges in your lung. You might notice swelling and pain, but some people have no symptoms. That’s why it’s a good idea to break up long sitting sessions.
You’ll gain weight
Watch a lot of TV? Surf the web for hours on end? You’re more likely to be overweight or obese. If you exercise every day, that’s good, but it won’t make a huge dent in extra weight you gain as a result of too much screen time.
Your anxiety might spike
It could be that you’re often by yourself and engaged in a screen-based activity. If this disrupts your sleep, you can get even more anxious. Plus, too much alone time can make you withdraw from friends and loved ones, which is linked to social anxiety. Scientists are still trying to figure out the exact cause.
It wrecks your back
The seated position puts huge stress on your back muscles, neck, and spine. It’s even worse if you slouch. Look for an ergonomic chair — that means it’ll be the right height and support your back in the proper spots. But remember: No matter how comfortable you get, your back still won’t like a long sitting session. Get up and move around for a minute or two every half hour to keep your spine in line.
It leads to varicose veins
Sit for too long and blood can pool in your legs. This puts added pressure in your veins. They could swell, twist, or bulge — what doctors call varicose veins. You may also see spider veins, bundles of broken blood vessels nearby. They usually aren’t serious, but they can ache. Your doctor can tell you about treatment options if you need them.
If you don’t move it, you could lose it
Older adults who aren’t active may be more likely to get osteoporosis (weakened bones) and could slowly become unable to perform basic tasks of everyday life, like taking a bath or using the toilet. While moderate exercise won’t prevent it, you don’t have to go out and run a marathon or take up farming to stay mobile in your golden years. Just don’t plant yourself on the couch for hours at a time.
Your cancer risk goes up
You may be more likely to get colon, endometrial, or lung cancer. The more you sit, the higher the odds. Older women have higher odds of breast cancer. That doesn’t change if you’re super-active. What matters is how much you sit.
How to take a stand
Work more movement into your day: Stand up and stretch every half hour or so. Touch your toes. Take a stroll around the office. Stand at your desk for part of the day. Get a desk that raises or make your own: Set your computer on top of a box. Talk to your boss about a treadmill desk. All these things can help stop the negative effects of uninterrupted sitting and keep you on the road to good health.
Tip adapted from webmd.comiii
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