Opting out of active management
In a letter published by the FT (8th August) I explain the active management problem from the client's perspective.
The letter was prompted by one (4th August) from Charles Plowden, A pity to deny the next generation exposure to active fund management. Charles in joint senior partner of Edinburgh fund managers Baillie Gifford. He made a number of points about the merit of active management. I chose to respond in general, his being typical of the way the case is made. It almost always overlooks the fact that the problem of selecting and then living with the selection of active managers or funds (as opposed to tracking indices) looks very different from the perspective of the client or end investor.
My letter in full is here: Opting out of active management.
'...the problem for the end investor is different. True, the investor may start with the plausibility of there being skilled managers, able both to identify individual winners and to construct a winning combination or portfolio. Assume she believes that there are, or she is not sure but values the option that there might be. Now she needs either to select the managers herself or to select an agent who is skilled at selecting skilled managers. That makes three skills that are not the same, each having its own tests of plausibility.
Even this is still an over-simplification because investor and agent face not so much a selection problem as a constant reselection problem, as new performance data arrives. An active manager taking large enough bets to beat a benchmark with equivalent risk (so not a closet indexer) will at some point experience poor performance and when it happens yesterday’s star stock picker may be hard to distinguish from a dog. With no help from the data, both investors and agents fall prey to behavioural biases in interpreting what is happening, the handling of which will probably explain outcomes better than the underlying active-management function itself.'
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