Who Is Passive?
Based on My True Stories, I’ll Let You Decide
Not long ago, I noticed 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 of time I spent at a firm that had two different investment management divisions on two different floors.
These two divisions had very different internal cultures as well as different approaches to investing – approaches that today are called passive and active.
A few people asked me tell this story in a little more detail, so here goes.
In the late 1980s, I worked in an equity investment division that was, by any standard, extremely active. 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) and sometimes we had joint meetings on their floor (their conference room was much nicer than ours). On this other floor, the pace felt much slower and the energy was much lower. 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 and that lunches 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 trading floor and didn’t really question the research provided to them by institutional equity sales professionals. They held what people at the time called “buy and hold ABC portfolios” (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 (they didn’t have systems to track daily net of fees performance).
Based on the descriptions of the activities on the two floors I mention, which investment division would you call active versus passive?
Without my lead-in, my 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 the 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 high-net-worth individuals and foundations. Based on meetings that I still have at the firm from time to time, not much has changed. Their ABCs now include Alphabet, but changes are few and far between. 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 labels invoke, and how they can drive investor behavior.
According to the dictionary, “active” means “vital” and “dynamic” and has synonyms such as “hard-working”, “diligent” and “effective.”
By contrast, the word “passive” means “inert” and has synonyms such as “docile,” “acquiescent” and “compliant.” Its literal antonym is the word “active.”
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 socialized to place a premium on people and processes that are diligent and effective (active).
Translating this to investing, pause a moment. How do you feel when you hear that certain types of investors are called Passivists? Chances are, not so great.
Yes, regardless of your investment background, deep down you are likely to be more attracted to an investment or firm that sounds dynamic and vibrant versus one that sounds docile and inert.
Words matter and, related to the terms used to describe the work of investment managers or advisors, are labels sometimes wholly divorced from how actively or passively professionals work and the processes they employ?
I think so.
I’m sure many will offer alternative stories and experiences. I welcome comments and only ask that more people think about this…
Back in the 80s, index investing existed, was already large and growing (we managed multiple hundred million dollar plus accounts for the likes of CalPERS, etc.), but I can’t remember hearing the terms passive or active.
Why is it, then, that today, professionals like the ones working on my old more active floor are now called passive and the more passive acting professionals on the other floor I mentioned are called active?
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