Passive zealots are actively deluding themselves

Andrew Alexander

Passive investing is a myth, marketed by product providers and sold on by many advisers as being more wholesome, or certainly more investor-friendly, than their unabashed ‘active’ counterparts.

But investing within an index does not remove you from active decisions; it simply means you are investing in a group of stocks picked by committee.

Take, for example, the S&P 500 index. You are taking an active decision to invest in 500 US stocks. Every point you deviate from the one index, the more active your investment decision becomes, even though certain parties look to misrepresent their active decisions by veiling them with terms such as ‘factor tilting’, ‘smart beta’ or other such devilry.

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The biggest worry? It’s that the vast majority who are zealously passive do not have any inkling that they are making active investment decisions every day.

This somehow makes them feel like they are removing their behavioural investment biases and possibly even justifying their lack of investment focus in their client recommendations.

But fundamentally, if you are only selecting index vehicles, you are actively selecting active indices to populate your actively chosen asset allocation. Just on the cheap.

Pot meet kettle.

Andrew Alexander is director at Lakewood Portfolio Management