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I love reading all things personal finance. When I came across this article from Barron’s, it really made me think.
Barron’s recently interviewed James Montier of the investment management firm, Grantham Mayo van Otterloo. You may have never heard of this investment firm. I hadn’t. But then this quick little blurb caught my eye. Their founder, Jeremy Grantham, famously predicted the 2000 and 2008 stock market downturns.
I figured if the firm’s founder could foresee the top of the market twice, this article might be worth reading. So, I delved in, and right off the bat, the first question intrigued me. It’s a great one that I often think about as well.
I thought for fun that I’d try to do something new. Read as I break down James Montier’s responses and provide my personal commentary, as if I were in the room to offer my insight.
Barron’s: Bonds are expensive, stocks are expensive. What’s an asset allocator to do?
MSM: If you’ve read my blog before, you know that I think timing the market is a big waste of time. Whether the market is at the very top or very bottom, that shouldn’t deter you from buying.
In my opinion, you should continue buying based on your asset allocation. For some people, that means having a 60/40 split between stocks and bonds. Others follow Dave Ramsey’s advice of investing into four buckets of money: Growth, Growth and Income, Aggressive Growth, and International. While others, such as JL Collins, recommend going with VTSAX.
Personally, JL Collins has put together the best argument on asset allocation that I’ve seen. I definitely encourage you to read his Stock Series if you’re curious to learn why he believes that VTSAX is the preferred investment vehicle.
Montier: Things just don’t add up. One group has thrown in the towel and says, “If you can’t beat them, join them. I’m just going passive and be damned.”
MSM: Yes, there is a large group who has thrown in the towel and believe active managers can’t beat passive managers. They advocate not wasting money on these managers’ fees.
Passively managed funds now account for more than 36% of the market, compared to 28% the year before. Is 8% is a big deal, though? Well, more than a $1 trillion has shifted from actively managed funds to passively managed funds. Or think about it this way. The loss of the lucrative 1% fee of these actively managed funds has resulted in a loss of $10 billion in potential revenue.
That is a big deal!!
As a comparison, Charles Schwab and TD Ameritrade last year had a combined revenue of $10.7 billion. You can see why some of the larger brokerage firms are paying close attention.
For that matter, over the last three years, Vanguard has had inflows into their funds of over $800 billion. The rest of Vanguard’s competitors brought in $97 billion combined.
As a result, these brokerage firms are now trying to compete with fees.
Montier: [Passive investing] is a very strange thing to do at this particular point in time.
MSM: Yes, this is a very strange to do (sarcasm). Actively managed funds have consistently underperformed the market. Instead of continuing to underperform, investors have moved their money into an investment that will at least generate the same market returns.
This seems to be the opposite of strange to me. In fact, it would be smart to do so. But what do I know? I’m not trying to make money off of people while underperforming my benchmarks.
An Expensive Market
Montier: The U.S. market is at its second or third most expensive point in history. So people are saying, “I either don’t understand the world anymore, or I don’t think that valuation matters anymore,” which is a really weird thing to say. You’re giving up the one piece of information that you know helps determine your long-term returns.
MSM: The market always seems expensive during a bull market. I still remember looking at Apple in 2009 thinking that $84 for one share was really expensive. Never mind since then, they did a 7 for 1 split, and each share is now worth $150, or unadjusted for the split, $1,050. I’d love to go back in time and splurge on some $84 Apple shares. For that matter, I’d also love go back and dump more money into the market before Trump was elected, since the market has gone up 20% since then.
While it’s inevitable that the stock market will eventually come back to earth, nobody knows when. Although, some people are pretty confident in their guessing abilities. An example is investor Jim Rogers. If you haven’t heard of him, you can google him to see how often over the last few years he has predicted an impending recession.
I think you get the picture.
Back to Passive Investing
Montier: You cannot describe yourself as an investor if you are going passive. You are welcome to call yourself a speculator, but you honestly can’t say you care about expected returns if you are going passive at this time.
MSM: Let’s do a quick look up of the definition of both investor and speculator. Then you can decide which one of us, the active buyer vs. the passive buyer, fits into which category.
- a person who forms a theory or conjecture about a subject without firm evidence.
- a person or organization that puts money into financial schemes, property, etc. with the expectation of achieving a profit.
Since actively managed funds as a whole have consistently underperformed the market, I would consider that they themselves are speculators. Passive buyers, on the other hand, are investors since they have fact-based evidence that passive investing works.
Montier: For those standing against the tide, there are a couple of challenges. One, how much pain can you take? The U.S. has been an incredibly strong market for a number of years, so going passive is classic returns-chasing behavior. How do you manage the pain? Nothing in the precepts of being a value investor tells you about the path or the timing. It just tells you about the final destination. The light at the end of tunnel is that the more that people buy on the basis of market cap, the greater the opportunity for active managers.
MSM: I have a mixed emotions here. I believe that with the money rapidly leaving actively managed funds for passively managed funds, this will force all but the very best active managers to survive.
The lesser-performing active managers will be pushed out of the industry, which is honestly a good thing. For far too long, Wall Street has made money off of people’s ignorance. With advice accessible for everyone, I believe we will continue to see passive funds squeeze out wealth managers and an increase in robo-advisors, such as Betterment and Personal Capital. These companies use algorithms to take the human element out of managing other people’s money.