Passively managed mutual funds and exchanged-traded funds have seen their coffers swell by nearly $1.3 trillion over past three years, according to Morningstar data. Nearly a quarter-trillion-dollars’ worth of the intake has been redirected from actively managed funds.
The move toward passivity will gain momentum. Government regulators are nudging retirement-plan sponsors to embrace passive investing. And when nudging fails, a lawsuit to cudgel frequently awaits.
Plaintiff lawyers have tapped a new revenue source. More of them are filing lawsuits against corporations, contending breach of fiduciary duty. By allowing higher-priced actively managed funds into their retirement-plan offerings, corporations are fleecing the great mass of unwashed self-directed retirement-plan investors, the barratry logic goes.
Ready to Embrace Passive Investing?
So, is it time to side with the trend and go passive?
Color me skeptical. I see more marketing style over investing substance in the rush to embrace passive investing. The word “passive” is really a misnomer. All investing is active investing. The difference is a matter of degree and control.
Even a large passive index fund like the SPDR S&P 500 ETF Trust (NYSEArca: SPY) is actively managed. Each year, 20 to 25 companies are added or removed from the S&P 500 Index. If we look at the S&P 500 today compared to 1999, we’ll find that half the companies the index comprises weren’t comprised in 1999. What’s more, because the S&P 500 is a market-weighted index, the weighting of the individual components will change. Who’s responsible for rebalancing by weight and choosing who stays and who goes? Standard & Poor’s. Someone somewhere is actively managing and always is.
Yes, it’s true: Fees on putative passively managed funds are lower than their actively managed counterparts. The Vanguard 500 Index Fund (NYSEArca: VOO) takes only 0.5% of the assets it manages annually. The Fidelity Magellan Fund (FMAGX), a large-cap actively managed fund composed mostly of S&P 500 stocks, takes 0.83%. Over the past five years, the Vanguard fund has outperformed the Fidelity fund. The annual fee differential contributes to Vanguard’s superior performance.
That said, the individual stock picker can still out-cheapskate the most parsimonious and passively managed fund.
If an individual stock-picking investor were to invest $100,000 in 15 stocks (an efficient portfolio can be constructed with as few as 15 stocks – read here) and if he were to hold these stocks for a year, his portfolio expense would unlikely exceed 0.15% of his assets. Few online brokers charge more than $10 per trade. And if fees related to any advisory services are added to the tally, total expense attributed to the stock-picked portfolio will still undercut any institution fund.
It’s All About Control
Control, though, is the insurmountable advantage bestowed to the individual stock picker. This investor can buck the crowd to lower risk and exploit opportunities the crowd is sure to ignore. He can implement his own bespoke investment strategy, and he can adhere to that strategy through thick and thin sans the need to genuflect to any institutional imperative.
And when market volatility rises, so does the risk of a broad-based market sell-off. The individual stock picker simply stands aside when the inevitable stampede for the exit occurs. His investment portfolio won’t be correlated with every other investment portfolio.
Best of all, successful stock picking is within the purview of any intelligent layperson. After all, if an intelligent janitor can pick stocks to amass a multi-million-dollar fortune, why can’t you or I?
VOO shares rose $0.16 (+0.08%) to $196.36 in Wednesday morning trading. Year-to-date, the third largest ETF tracking the S&P 500 index has gained 5.05%.
This article is brought to you courtesy of Wyatt Research.