What you see is all there is. Indices along with their passive investors seem to think this is the way to better and this is all you need. They claim indices are simple and easy to understand, have lower cost, and are diversified. That investing is as easy as finding an index to match the exposure wanted. True, but this type of thinking can be unhealthy for a portfolio.
Consider Huishan Dairy, a component of the MSCI Asia Pacific Index. Tuesday last week the price fell 90% in one hour. Aggressive accounting was the culprit. Research was the sleuth and had communicated the problem well in advance of Tuesday’s fall. Active managers had heeded the warning. Indices are not perfect and some are better than others. Active managers are big users of research and are better at ferreting out the things that investors should avoid. But active management costs more and costs are a drag on performance. Performance needs to justify the cost or why bother.
Last week we outlined the active versus passive debate and mentioned some results of different studies. In one, RVK Investments concluded that active outperformance was correlated to a dispersion effect. The more volatility the better active performs. Makes sense. And, if a shift in any of the factors that drive market returns takes place, active will shine and investors will be glad they paid a little more. After all, what you see is not all there is.
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