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If You Can’t Beat Them, Join Them

Published by: Nathan Smith Date: January 31, 2020

The Wall Street Journal reported that billionaire founder of Dell Computer, Michael Dell had made the strategic decision to significantly change the way his $16 Billion family office (MSD Capital) invests their funds. The change has been made after nearly two decades of operation to wind down the stock-picking portion of the portfolio. MSD Capital is highly regarded in the industry as having the most sophisticated family office, which means that they have investments that aren’t readily accessible by ordinary investors. Investments like hedge funds, private equity, and all manner of investments that sound cool and exclusive. The firm’s management cited the rise of passive (index funds) and quantitative (factor funds) investing and the long duration of the current bull market as the primary reasons for deciding to join them rather than trying to beat them.

This past year was an important milestone for the active versus passive battle as the number of dollars of U.S. equity funds invested in passive funds for the first time surpassed that of active funds. As the chart below highlights, the rise of passive management has been relentless during the past decade compared to active fund managers.

With half of U.S. equity funds invested between passive and active funds, which one is best for investors?

While that is an extremely loaded question, the trend would suggest that more and more investors are jumping over to the passive side of the fence. What I would offer is that investors need to find the best solution that will lead to the fulfillment of their long-term financial goals. Investors typically fall into one of the following categories when they think about the best way to invest in their future.

Examples of each category are pretty obvious to see, but one that I wanted to highlight is exclusive access. These are the investments mentioned above that seem to offer potential opportunities and access to markets and products that are outside the reach of most normal investors. This exclusivity is said to be able to generate above-market returns, but research proving this claim has yet to be found. Warren Buffet’s famous bet comes to mind.

What the debate between active and passive boils down to is whether or not an investor believes that they or a professional can outperform the market over the long-term. Many people still believe that markets are a solvable Rubix cube. In the wake of the 2008 financial crisis, many investors were taken hold by stories of the few hedge funds that not only saw the crisis coming but made an untold fortune from the turmoil that ensued. These managers were revered in the financial press and were quick to profit from their timely bets by predicting the next shoe to drop. But more than ten years later, many of the darling funds have seen their assets decline by more than 50%. It reminds me of the famous Yogi Berra quote, “making predictions is hard, especially about the future.”

Instead of relying on the promise of investments that offer exclusive access, in our opinion, investors will be better served by joining the millions of investors that have embraced evidence based passive investing rather than trying to beat the market with active strategies.