Removing Active Management Biases

April 21, 2022

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Basing your investing strategy and performance scorecard on whether a mutual fund beats its benchmark is “irrational” according to a new piece in The Mutual Fund Observer by author David Snowball. His article was part of a pair of point-counterpoint articles in the publication that try to go beyond the headlines and ask critical questions about where active and passive are working and where they are not. Both Snowball and fellow author Devesh Shah urge investors to ask tough questions, do their research and consider all factors about active management, not just whether a fund is beating its benchmark.

A Destructive Obsession

In “Two Cheers for Active Management!” author David Snowball dives into the active management value proposition. He points out that the main metric — beating the benchmark — is like the “fantasy football” of investing, noting that investing success is not beating the markets, it’s achieving your financial goals. He writes that obsessing over beating benchmarks is “destructive” and highlights that if you routinely beat the market but fail to achieve your goals you “lose.” In the same vein, he points out that “if you trail the market ten years in a row and the sum of your resources is greater than the sum of your needs, you win.”

Managing Risk

Another important element to the active management value proposition is managing risk. “I rely on active managers to make prudent risk adjustments on my behalf,” he writes, noting the time-consuming and potentially portfolio harmful nature of doing it yourself. And Snowball writes that investors can find a manager to suit their needs in advance. The author looks for a variety of attributes before he invests including risk management, breadth of investments, track record, investing style and more.

Every Decision is Active

Snowball also points out that quite simply, there is no such thing as truly passive investing. “Each of those decisions represents an active bet on your part that one set of options will be more satisfying than another.” Snowball remarks that the S&P 500 is simply a low-turnover actively managed fund, as Standard & Poor’s chooses companies in the index. He writes that all passive funds represent “a series of complex and active decisions.”

A Passive Investor Challenges Assumptions

For a view of active management from a different perspective, let’s look at the counterpoint article written by Devesh Shah “On Active vs. Passive Equity Mutual Funds.” Shah is primarily a passive investor and an active skeptic. After reading a quote from Peter Lynch that passive investors are ‘making a mistake,’ Shah decided to do some research to see if he can get beyond his ‘confirmation bias’ when it comes to active equity funds.

Superb and Consistent Outperformance

Shah analyzed a variety of funds from several firms. He found that some of his biases were correct, but others were disproven. Shah writes he “learnt that superb and consistent outperformance exists in a Mutual Fund, even in today’s benchmark-driven passive market.”

Forming Faith on Active

Shah found that the acumen of an investment manager can add value writing that in the case of one fund, “outperformance has been driven by significant active movement in the portfolio.” That opened his eyes to the fact that successful fund managers can be identified in advance. “I am open to reading and learning more about successful MF managers so I can form faith,” he writes.

You can read more about active vs. passive and take a new poll on investing styles at the Mutual Fund Observer website.