COVER STORY
Case closed
I ’ ve been writing about the futility of paying for active management for more than a decade now , and I recently made a conscious decision that it ’ s time to stop . I ’ ll explain why later , but when Trustnet Magazine asked me to write about whether I “ remain convinced that passives are still the place to be ”, I decided to give it one last go . So here it is . First of all , I should clarify : I ’ m not saying low-cost indexing is the perfect way to invest . It isn ’ t . I ’ m simply saying that it ’ s far better than the alternative . The case for indexing is essentially based on two simple pieces of maths . Thankfully , for those of us – myself included – who aren ’ t natural mathematicians , neither is very complex .
A zero-sum game The first mathematical point is about averages and markets . Active and passive funds are investing in the same markets , but in different ways . Unfortunately , each market is a zerosum game , so for one active manager to win , another must lose . Active managers aim to be better than average – to beat the market . Some will , some won ’ t , while others will hover around the median . The problem is , they all charge fulsome fees . Active management is not cheap and , almost without exception , you pay the fees regardless of how well or badly managers perform . Crucially , though , it ’ s hard to tell in advance which camp your chosen manager will turn out to be in . Of course , they will claim to be able to beat the market , but , by the law of averages , it ’ s just as likely that they won ’ t . An argument we often hear from advocates of active management is that when the market falls , so does the value of your index fund . Active managers , on the other hand , have the flexibility to limit your losses . In theory , that ’ s right : they do have the potential to limit the damage . What they don ’ t tell you is that , in practice ,
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