A recent article in the NY Times titled “The Oracle of Omaha, Lately Looking a Bit Ordinary”, has prompted me to finally write a new blog.
The NY Times piece, by Jeff Sommer, highlights research by Salil Mehta, on his blog Statistical Ideas, about the virtues of index investing. It is yet another piece that discusses how hard it seems to be to find managers that can consistently outperform index funds.
At SJM Fiduciary, we use active managers for some asset classes such as emerging market equities and ESG / SRI mandates, and, prior to starting my own firm, I spent the better part of 25 years successfully selling active management (was a Managing Director at firms that largely promoted active strategies).
In addition, I previously posted my thoughts on how investors might find a manager who adds alpha using Active Share screens titled, “A Way to Outperform Over Time?”.
Across the vast majority of equity asset classes, however, I actively encourage and implement investment plans with index funds.
Beyond consistently outperforming many active funds (some research suggests the majority), having low fees, being very transparent (easy for clients to understand what they are investing in and how they are doing), completely liquid and tax efficient, I think implementing index strategies adds value in other ways.
I have come to feel that the wealth and investing business spends too much time and money promising and selling the ability to pick a manager or strategy that can outperform an index. Considering how hard it is to deliver on these promises, and how many resources (firm time and client fees) are spent in pursuit of something that a good amount of research indicates is very elusive, I feel we should be focusing more on other things.
Versus trying so hard to find and sell alpha, maybe we in the industry should be spending more time trying to understanding clients’ feelings about risk and reward (not presenting output from questionnaires or Monte Carlo simulations), giving full transparency (openly discussing both sides of a trade, fully disclosing all terms, potential biases and conflicts, etc.), and, importantly, making investors comfortable with their investments, so they have a greater likelihood of sticking to their plans.
Investing should not be a competition, it should be a tool that allows a person or an entity to reach specific goals (a means to an end).
If more advisors used index funds, it might reduce what, based on many research pieces similar to what is mentioned in the NY Times article, could be relatively unproductive competitions to find and sell alpha.
In addition, I feel that it would allow us to devote more time and resources to improving client experiences and forming stronger relationships.
I am finding that more and more clients desire simplicity. Even Warren Buffet seems to have feelings that tilt this way. The NY Times article I mentioned above reports that Buffet has given instructions for a family trust to, “Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund.”
Humans are inherently competitive, and index funds are not for everyone (some want to strive to find the New New thing), but I feel that the aggressive pursuit of alpha at the potential expense of greater simplicity, transparency and, in many cases, better performance, should be discussed more directly with clients.
More than selling alpha, relative performance and relative risk metrics (Sharpe ratio comparisons, etc.), let’s spend more time openly discussing both sides of topics, such as the active vs. passive debate, listening to clients and implementing strategies that increase comfort.
If we spent more time offering transparency and peace of mind, I think it would increase trust in our industry as a whole and help us form more lasting client partnerships.