ACTIVEINVESTING:RESTINPEACEORRESURGENTFORCE?

AswathDamodaran

TheActive/PassiveDivide

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JackBogle,theGreatestDisruptor?

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TheDisruptionPaceQuickens

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Andthefundflowsbackitup

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1.ActiveInvestingcannotcollectivelybeatthemarket… here’swhy..

¨ During2015,forinstance,about40%ofinstitutionalmoneyinequitieswasinvestedinindexfundsandETFsandabout60%inactiveinvestingofalltypes.

¨ ThemoneyinvestedinindexfundsandETFswilltracktheindex,withaverysmallpercentage(about0.11%)goingtocovertheminimaltransactionscosts.

¨ Thus,activemoneymanagershavetostartoffwiththeacceptancethattheycollectivelycannotbeattheindexandthattheircosts(transactionsandmanagementfees)willhavetocomeoutoftheindexreturns

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Andtheydon’tcomecloseindeliveringreturns..

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Orinbeatingtheirpassivecounterparts

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2a.Andtheunderperformancecutsacrossstyleclasses

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2b.Andacrossgeographies..

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3a.Thereisnoconsistency..Winnersdon’tstaywinnersforlong

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3b.Andsuperstarmanagersfadequickly..

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ActiveInvesting’slastgaspdefense..

1.84

2.272.42

1.90

2.62

1.91

1.33

1.62

1.87

1.57

1.82

1.611.521.52

1.80

1.07

1.541.37

1.211.341.29

1.51

1.30

0.00

0.50

1.00

1.50

2.00

2.50

3.00

$0

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

$350,000

$400,000

BerkshireHathaway:TheFadingBuffettPremium

P/BVRatio MarketCap BVofEquity

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TheFutureofActiveInvesting

Aswath Damodaran

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¨ Theactiveinvestingbusinesswillshrink:Feeswillcontinuetodropbutmarketsharewillalsocontinuetodecline.Itwillbelessprofitableandhirefewerpeopleasanalysts,portfoliomanagersandsupportstaff.

¨ Moredisruptioniscoming:Thebusinessesthataremostripefordisruptionareoneswherethebusinessisbig(intermsofdollarsspent),thevalueaddedissmallrelativetothecostsofrunningthebusinessandwhereeveryoneinvolved(businessesandtheircustomers)areallunhappywiththestatusquo.Thatfitstheactivemoneymanagementperfectlyanditshouldcomeasnosurprisethatthenextwaveofdisruptioniscomingfromfintechcompanies

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TheDarkSideofPassiveInvesting?

¨ CorporateGovernance:Thecritics ofpassiveinvestorspointtothefactthatVanguardandBlackrockvotewithmanagementmorethan90%ofthetime.

¨ InformationEfficiency:Activeinvestorscollectandprocessinformation,tryingtofindmarketmistakes,theyplayaroleinkeepingpricesinformative.Thisisthepointthatwasbeingmade,perhapsinartfully,bytheBernsteinpieceonhowpassiveinvestingwasworsethanMarxismandleadingtoserfdom.

¨ ProductMarkets:Therearesomewhoarguethatthegrowthofpassiveinvestingisreducingproductmarketcompetition,increasingpricesforcustomers,andtheygivetworeasons.¤ Thefirstisthatpassiveinvestorssteertheirmoneytothelargestmarketcap

companiesandasaconsequence,thesecompaniescanonlygetbigger.¤ Thesecondisthatwhentwoormorelargecompaniesinasectorareownedmostly

bythesamepassiveinvestors(sayBlackrockandVanguard),itissuggestedthattheyaremorelikelytocolludetomaximizethecollectiveprofitstotheowners.

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YourChoices

¨ Shouldbeanactiveorpassiveinvestor?Thereisnooneanswerthatwillfitallandeachofushastomakethejudgmentthatbestreflectsus(bothintermsoffinancialstandingandpersonalcharacteristics).

¨ AsIseeit,youhavethreechoices:¤ Gopassive:Decideonhowmuchriskyouwanttotake,diversifybroadlyand

holdindexfunds/ETFstomatchyourriskprofileandcashflowneeds.¤ Goactive:Thiscanrangethespectrumfrommarkettimingtostockpicking,

shorttimetolongtimehorizonsanddifferentinvestmentphilosophies.¤ AHybrid:Youcanmixactiveandpassiveshiftingfromonetotheotherover

timeorusingoneforonepartofyourportfolio(pensionfund)andanotherforadifferentpartofyourportfolio(savings).

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Herearemine..

¨ Iamanactiveinvestor ontheportionsofmyinvestmentportfoliothatIcancontrol.MyjustificationisnotthatIhavebetterinformation,canprocessthatinformationmoreefficiently(invaluationmodels)orthatIhavespecialinsightsonmarkets.

¨ Ihavetwofactorsworkinginmyfavor:¤ Iunderstandandgetalongwithmyclient.Iinvestformyself.¤ Ihavefaith invalueandthatmarketpricesconvergeonvalue.

¨ Thatsaid,Iwillbeatpeacewithmyself,ifattheendofmyinvestinglife,IlookbackatthereturnsthatIhavemadeandconcludethatIcouldhavedoneaswellorbetter,investinginindexfunds.Ienjoyinvesting.

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