Why Active Investors Achieve Only Benchmark Returns
Wall Street “experts” would like you to think the era of superior stock selection is dead. How many times have you heard, “You can’t beat the market average, so don’t bother trying?”
Let’s examine the premise. By definition, active investing is the opposite of passive investing. Investopedia’s defines Active Investing as follows:
Active investing is an investment strategy involving ongoing buying and selling actions by the investor. Active investors purchase investments and continuously monitor their activity in order to exploit profitable conditions.
Passive investors, on the other hand, presume they are unable to outperform their benchmark index and thus aim to own the securities comprising the index. Since indices are nearly static in nature, a passive investor will have relatively low portfolio buying and selling actions.
Given the prevailing sentiment most portfolio managers face – the assumption they can’t outperform a static benchmark index despite their best efforts – many attempt to mimic their benchmark, making minor adjustments or employing trading strategies to add incremental returns in excess of the benchmark.
It appears many so called “active” investment managers are simply investing in the benchmark effectively becoming “passive” managers. How could this be? Active managers are paid to add value through intelligent analysis and action. Yet a disproportionate number of them are regularly unable to outperform the very benchmark to which they compare.
The late investor Sir John Templeton famously stated, “If you buy the same securities everyone else is buying, you will have the same results as everyone else.” Too many investors have an objective of simply achieving market average returns. Templeton was right. To produce non-average results an investor must have the conviction to hold securities that are different from most other investors. Templeton’s statement shines the spotlight on the core reason so many investment managers perform closely to the benchmark. These investors are trying to invest like the benchmark. Most active managers are reluctant to invest differently than the benchmark for fear of criticism if they underperform. They prefer to be benchmark-like to avoid having to explain why the securities they hold have diverged in performance from the benchmark.
On the other hand, there are investors who have achieved results well in excess of their benchmark over time as a result of investing in high conviction securities. High conviction securities are those the investor believes will produce outsized returns over time. These investors, like the securities they hold, are uncommon.
When selecting an investment strategy it is wise to compare the portfolio makeup in relation to its benchmark index. If they look alike, the strategy is probably a benchmark in disguise.
Active management necessarily means investing differently than an index. Active managers must have a thorough understanding of each security owned and focus only on their best ideas. Active managers have a short list of holdings – between 20 and 30 issues. Active managers have low levels of activity as they wait for each investment to mature, not simply riding the wave of popular trends or market euphoria creating broad based rising share prices. Active managers have few constraints, desiring to invest in companies of all sizes, across many industries, and in multiple geographies around the world. Finally, active mangers know who runs the companies they hold, engaging in discussions frequently with senior management and occasionally bouts of shareholder oriented activism to defend the interests of the very client and shareholders by whom they’ve been retained.
Any investor considering hiring and active managers should require these qualities in their manager. If absent, then keep searching for managers who possess them. If unable to find one, call our firm, we are active and activist managers.
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The opinions expressed herein are those of Global Value Investment Corp. (GVIC). The data is furnished for informational purposes only and should not be relied upon as the basis for an investment decision. Although it is derived from sources believed to be accurate, GVIC cannot guarantee the accuracy of statistical information. This publication is intended for information purposes only and shall not constitute an offer to buy/sell or the solicitation of an offer to buy/sell any security mentioned. This publication and all information, comments, statements or opinions contained or expressed herein are applicable only as of the date of this publication and subject to change without prior notice. Past performance is not indicative of future results.