WORLDVIEW: Active v Passive – Desperate times, desperate arguments. Don’t buy them.

I'm delighted to welcome our latest contributor to Worldview – my hugely talented long-time colleague Felicity Duncan. Those who discovered Biznews in the very early days will recall her superb contributions. And will be as excited as me to have our Fulbright scholar (and ex US journalism prof) on the Worldview team..SA born and bred but now based in Philadelphia, Felicity graduated from the Moneyweb internship programme and progressed swiftly to head the company's editorial team. She and the inimitable Jackie Cameron did much to help get Biznews off the ground..In today's contribution, Felicity puts the spotlight back on the investment world's big battle between active and passive managers – one the former is winning hands down. It looks to me a little like desperate times require desperate measures….___STEADY_PAYWALL___.Felicity writes: "I'm a big fan of passive investing. For the average investor, stock picking is a risky business, and actively managed funds' fees bleed out most potential upside. So, for a regular person with a long horizon, passive investing is a solid option..But, as money has flowed out of active funds into passive ones, there've been critics complaining that passive investors are ruining everything..For example, hedge fund manager Paul Singer recently said passive investing is in danger of "devouring capitalism". (It's worth noting his flagship fund delivered a 0.4% return in the second quarter and many hedge funds are seeing serious outflows, which makes this seem a bit like sour grapes.).Billionaire's diatribes aside, there are some serious academics who worry about the impact of passive investing..Specifically, one famous study found that "common ownership" has pushed up prices in the airline industry. "Common ownership" is when investors own a broad, diversified portfolio. When this happens, companies acting in the best interests of their shareholders may avoid competition, which pushes down prices, in favour of co-operation..Think about it like this: If I own one airline, I want it to steal customers from the other airlines, perhaps by lowering prices. But if I own all five airlines, I want them all to raise prices, because that would maximise my returns..The idea, then, is that if millions of small investors are building passive, broadly diversified, low-cost portfolios, they'll want all the big companies they own to do anti-competitive things like raising prices and strangling new competitors. Some economists therefore want government to prevent funds from owning more than one company in a sector or to reduce funds' voting rights..From where I sit, this seems wrongheaded..Most small investors consistently underperform the market for two reasons: first, they try to time the market and end up buying high and selling low, and second, they lose a big chunk of their upside to fees..Passive investing gives small investors a way to build diversified portfolios with low costs, just like institutions have had for decades. In other words, they let the little guy harness the power of capitalism too..Letting passive investors hold diversified, low-cost portfolios doesn't stop hedge fund types like Singer from betting against passive investors by buying a company, pushing it to compete, and earning market-beating returns..In fact, the more passive investors there are, the more theoretical opportunity there is for active managers. If there's not enough competition in the economy, don't blame passive investors. Blame the folks whose job it is to make things competitive.".Mr Singer certainly won't be the last to look for a creative way to shore up the defences of an embattled hedge fund industry. But while talk is cheap, this is an area where the compounding impact of higher costs is what actually costs you the whiskey (and delivers worse returns).

WORLDVIEW: Active v Passive – Desperate times, desperate arguments. Don’t buy them.

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