Based on My True Stories, I’ll Let You Decide
While surfing Twitter one weekend, I noticed another long debate about the difference between passive and active investment management.
When the debate turned to the meaning and use of the words “active” and “passive”, I chimed in by sharing a brief tale about time I spent at a firm that had two different investment management divisions on two different floors.
These two divisions had very different cultures, as well as different approaches to investing.
A few people have asked me to tell my story in more detail, so here goes.
In the early 1990s, I worked in an equity investment division that was, by any standard, extremely vital and dynamic. The culture on the floor was fast paced, with investment market review and strategy meetings that started at 6am. Days were generally 10-12 hours long and it wasn’t uncommon to come in on weekends. We worked hard to analyze every aspect of what we did and diligently strove to optimize our performance to meet our investment mandate. This included proprietary quantitative and qualitative research conducted by a sizable group of CFAs and math PhDs about how the market was changing and how to most efficiently trade for the maximum benefit of our clients. Returns were evaluated daily versus our benchmark and our performance was reported monthly to clients, net of all fees and expenses.
A few floors below was another equity management group. I was just starting out, so I was often asked to carry memos back and forth (yes, this was a long time ago – emails were not common). On this other floor, the pace felt much slower. Even though we enjoyed the faster pace on our floor, sometimes we were a little jealous. It was well known that work on this floor generally started at 9am, lunches tended to run long and often took place in the executive dining room on the top floor of the building. When I visited, it wasn’t uncommon to see feet up on desks and very little apparent activity. Their investment operations and process was also quite different. Unlike us, they didn’t have a separate research group and held what people at the time called “buy and hold ABC portfolios” (generally one stock per letter of the alphabet – Anheuser-Busch, Boeing, Caterpillar, Dow, etc. – if it was part of the DJIA, it was considered just fine). The floor was generally empty by 5:30pm and I never heard of anyone there coming in on a weekend. This group sent reports to clients once a quarter, but they didn’t include performance figures and, if you asked them, they couldn’t readily tell you what their performance was versus their benchmark (they didn’t have systems to track daily performance net of fees and expenses).
Based on this, which floor or division would you call active versus passive?
Without my lead-in, my strong guess is that you would instinctively call the 10-12 hours a day, fast paced floor the active division and the more staid, 9 to 5 floor passive investors.
If so, you would be wrong.
The more active floor I sat on managed large institutional S&P500 index funds. They are now one of the largest index firms in the world and, from what I hear from friends working there, the pace is as active and dynamic as ever.
The other division was sold to another large firm, but it still exists and manages money for UHNW individuals and foundations. Based on meetings that I still have at the firm from time to time, not much has changed (some of the people are older but are still in similar hear-a-pin-drop offices). Their ABCs now include Alphabet Inc. but changes are basically nonexistent and they still don’t report performance on a regular basis. Also, when they do, it’s still gross, not net of fees and expenses (one of their most recent presentations is on my desk now). Bottom-line, it’s hard to call their approach anything but passive.
In saying all this, I’m not trying to win a debate about which style of investing is better. Boring and staid can perform well and, during different time periods, the arguably more passive buy and hold ABC portfolio that I described almost certainly outperformed the S&P 500 and vice versa.
Instead, I’m hoping that the next time you hear someone label a certain type of fund or ETF passive or active, you will ponder how it is being presented, the emotions the words and labels invoke, and how they can drive investor behavior.
As a reminder, the following are definitions of the words Active and Passive:
Active – Dynamic, Effective, Vital
Synonyms – Alive, Functioning, Working
Passive – Inert, Docile, Lacking Will
Synonyms – Acquiescent, Compliant, Resigned
Humans are hard-wired to be attracted to people and things that are vital. It’s a Darwinian survival instinct. We’re also generally competitive and tend to place a premium on people and processes that are effective – active.
Translating this to investing, pause a moment and consider these questions:
Regardless of your investment background, my guess is that deep down you are likely to be more attracted to an investment strategy or firm that sounds dynamic, alive, and effective versus one that sounds docile, lacking in will, or resigned.
In another past life I helped develop, market, and sell what are called actively managed equity funds. I was good at it, and even won an award for selling more actively managed equity funds than anyone in the history of my division. I can tell you that we had many training sessions on investor behavior and knew well how to use words such as active and passive to influence investors and sell products.
Back in the early 90s, index investing existed and was already large and growing. As an example, at the firm I mentioned above, we managed multiple hundred million dollar plus accounts for large pension funds and endowments. I can’t remember, however, ever hearing the terms active or passive used to describe an investment strategy or approach.
Why is it, then, that today, professionals like the ones working on my old more active floor are now called passive?