Active vs. Passive Styles of Investing

Don't tell me that "you can't beat the market" because there are certain investors that are able to do exactly that.  Peter Lynch of Fidelity Magellan fame certainly did well in his 23 year run.  Bill Miller of Legg Mason famously beat the S&P 500 fifteen years in a row.  Lynch retired at the top of his game.  Bill Miller made a disastrous bet on financials during the teeth of the last bear market and had significant drawdowns during that time.  Most recently the performance of Leon Cooperman's Omega Partners has garnered notice.  Cooperman has posted returns net of fees of 14.6% from January 1992 through June of this year.  The S&P's return during that same period is 9.3%.  Of note however, is that betting on Cooperman {assuming you could get into his funds} meant sticking with him during some periods of significant drawdowns as well.  He significantly underperformed the market in 1994 and was down substantially in 2008, although he did better than the S&P 500.

However, it should be noted that these gentlemen {and a few others I'm sure} are the exception to the rule.  Most active managers in don't beat the markets.  Year to date most styles of hedge fund investing are nowhere near the S&P 500's return.  Now it could be that given a particular investment style of the fund that is not it's intention.  But it is still useful to remember that the investors in these funds are typically paying a 2% management fee plus a performance bonus of 20% on the profits of the funds.  That's a lot to swallow in an environment where you could have earned over 6% this year and paid a fraction of that cost.

It's not much better with mutual funds.  As chronicled in a recent New York Times article, S&P Dow Jones Indices took a recent look at this in a study titled "Does Past Performance Matter?  The Persistence Scorecard".  I'll refer you to both the article and the study for the exact methodology,  however, the study found that among other things only a very small percentage {just 0.07% of 2,862 funds} beat the market during the underlying period.

We at Lumen Capital Management, LLC  favor ETFs which track indices for our investment strategies for just the reasons listed above.  Does that mean all active management is bad?  Of course not.  There can be instances where an investor wants exposure to an asset class or strategy where only an active manager will suffice.  For example in a classic hedge fund, i.e a manager with a long short strategy, it is to be totally expected that in a year where the markets are going gangbusters that he or she will underperform.  That fund's mission isn't to keep up with the averages, its to provide you a downward cushion in the event of a decline.   But for the most part almost anything an investor wants to do today can be replicated with a more passive approach for a lot less in expenses.  That's the way I see it and I'm happy to debate that point with anybody that wants to do so.

*Long ETFs related to the S&P 500 in client and personal accounts although positions can change at any time.