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Active v. Passive? Why It’s Not That Simple Anymore

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For the past five decades a radical idea has been eating away at the soul of the global asset management industry: What if you can’t beat the market? At least, not consistently. Then all the time, energy and — most important — money spent trying to do so is wasted. You’d be better off buying a so-called passive fund that holds all the stocks in an index like the S&P 500. This idea became an $11 trillion tidal wave of cash, bringing with it concerns about whether passive portfolios are distorting financial markets. Now the debate is shifting again. Rather than a black-and-white choice, active is getting more passive and passive is getting more active. What’s unclear is whether this will improve investment tools or re-create the inefficiencies of the past.   

In and around the 1960s, a confluence of factors (in particular the advent of computers) allowed a small group of academics to show exactly how most money managers were performing versus the U.S. stock market. The conclusion was famously articulated by Burton Malkiel in his 1973 book, “A Random Walk Down Wall Street,” in which he argued that “a blindfolded monkey throwing darts at the stock listings” would do as well as the pros. Trailblazers at firms including Wells Fargo & Co. and Vanguard Group Inc. developed index funds with the idea that by accepting “average” returns engineered by buying a broad swath of the market — but spending far less on fees — most investors would do better.