The debate about whether you should hire an “active” fund
manager who tries to beat the market by buying the best stocks and avoiding the
worst—or a “passive” index fund that simply matches the market by holding all
the stocks—is over.
Charles Ellis, widely regarded as the dean of the
investment-management industry, says hordes of portfolio managers will
eventually be thrown out of work—and financial advice could end up cheaper,
better and more plentiful than ever before.
Mr. Ellis is the founder of the financial consulting firm
Greenwich Associates, a former adviser to Singapore’s sovereign-wealth fund,
the author of 16 books and former chairman of Yale University’s investment
committee.
In an article in the latest issue of the
well-respected Financial Analysts Journal, Mr. Ellis argues that fund managers
equipped with sophisticated analytical tools, electronic trading and
instantaneous access to news are engaged in an arms race resulting in a kind of
mutually assured destruction of outperformance.
The faster and smarter each manager becomes, the more
efficient the market gets and the harder it is for any manager to beat it. As a
result, the money game of outperformance after fees is, for clients, no longer
a game worth playing.
Furthermore, some managers will beat the market, some by
skill and many by luck alone, even in today’s hypercompetitive environment.
While no one has ever come up with reliable ways of identifying those managers
ahead of time, that won’t stop many investors from trying. So active management
won’t disappear entirely.
But index funds and comparable exchange-traded portfolios
now account for 28% of total fund assets, up from 9% in 2000. And no wonder.
Over the past one, three, five and 10 years, only one-fourth to one-third of
all stock funds have beaten the index for their category, according to
investment researcher Morningstar.
Meanwhile, index funds effectively match the returns of
those market benchmarks at fees that often run only one-tenth of those of
active funds. Skeptics have pointed out that if individual investors are
rushing into passive funds, then active funds might be due for a resurgence. But the net supply of outperformance always is
zero; one fund manager can beat the market only at the expense of another who
must lag behind it.
To Mr. Ellis, the future for many portfolio managers is
clear. One obvious destination is financial planning. Tens of millions of
Americans need a financial adviser, but only a few hundred thousand advisers
are available—many of whom aren’t investing experts. In short, many stock pickers should get out of
the business of managing investments and get into the business of managing investors.
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here to access the full article on The Wall Street Journal.