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The Stampede From Active Management To Passive Investments

by Gary D. Halbert
December 6, 2016

1. The Rationale for “Active” Investing

2. The Rationale for “Passive” Investing

3. What You Really Need to Know About Active vs. Passive

4. Takeaways From Today’s Active vs. Passive Discussion

5. Halbert Wealth Management’s “Alpha Advantage Strategy”


Over the last decade, we have seen a massive shift on the part of investors away from so-called “actively-managed” mutual funds and exchange-traded funds (ETFs) and into so-called “passively-managed” funds – also referred to as “index” funds.

Over the three years ended August 31 alone, investors added nearly $400 billion to passive mutual funds and ETFs while draining more than $400 billion from active funds, according to data from Morningstar, Inc. That’s huge!

Actively Managed Funds

While the majority of mutual funds continues to be of the active-management style, that is rapidly changing. The question is whether the stampede from actively-managed to passively-managed funds is a good thing or not.

The Rationale for “Active” Investing

Actively-managed funds have a designated manager (usually a management team) that makes the day-to-day decisions on which stocks to own. The frequency of trading varies widely. The goal of active management is to equal or beat a particular benchmark (such as the S&P 500 Index or others).

Active managers believe that the markets are inefficient, and as such, anomalies and irregularities in the capital markets can be exploited by those with skill and insight. Prices react to information slowly enough to allow skillful investors to systematically outperform the market, they believe.

Analyzing market trends, the economy, company-specific factors, etc., active managers are constantly searching out information and gathering insights to help them make their investment decisions. Many have their own complex stock selection and trading systems to implement their investment ideas, all with the ultimate goal of outperforming the market.

Active management strategies vary widely from manager to manager. These strategies can include fundamental analysis, technical analysis, quantitative analysis and macroeconomic analysis, just to name a few. Active managers may, or may not, be fully-invested at all times. Some of the assets may be parked in cash (money market fund) from time to time.

The Rationale for “Passive” Investing

Passive management, or “indexing,” is an investment approach based on investing in exactly the same securities, and in the same proportions, as an index such as the Dow Jones Industrial Average, the S&P 500 or others.

It is called “passive” because the fund managers don’t make decisions about which securities to buy and sell; the managers merely construct their portfolios to be as identical as possible to the index they are tracking.  The managers’ goal is to replicate the performance of an index as closely as possible.

Passive investors believe that market prices are generally fair and quickly reflect all the relevant information available. They also believe that consistently outperforming the market for the professional and small investor alike is difficult, if not impossible. Therefore, passive managers do not try to beat the market, but only to match its performance.

Passively-managed funds, almost by definition, have lower fees and expenses than their actively-managed brethren. It is also important to know that passively-managed funds are usually fully invested at all times. If the stock market goes down, passive funds lose just as much as the market, or more due to fees and expenses.

Remember that the S&P 500 Index lost over 50% in 2007-2009, and most passive funds experienced similar losses. Keep in mind that it takes a 100% gain to recover from a 50% loss. That can take years!

What You Really Need to Know About Active vs. Passive

A debate about the two approaches has been ongoing since the early 1970s. I will tell you that there is no “pat” answer to this question, although I will explain my own preference as we go along today.

Each side can make a strong logical case to support their arguments, although in many cases, the support is due to different belief systems, much like opposing political parties. However, each approach has advantages and disadvantages that should be considered.

The goal of active managers is 1) to meet or exceed their benchmark index, and 2) to lose less than the market during down-trending periods. Keep that in mind as we proceed.

As for active management, the most important thing you need to know is that the vast majority of active managers have under-performed their benchmark indexes in recent years. Depending on whose numbers you read, some 60% to 66% of active managers have failed to match or exceed their benchmarks the last several years.

Their primary excuse is that the stock market has skyrocketed in recent years, and active management strategies shouldn’t be expected to keep up in such an unusual environment. Really? Are you buying that? I didn’t think so.

Just as important, many active managers experienced their worst losses in their histories during the severe bear market in late 2007-early 2009. The idea that active managers can get you out of the market, or at least minimize losses, blew-up big-time for many in 2008. Some lost almost or just as much as the S&P 500, which as you know was down over 50%.

Here is what you should take away from this discussion on active managers. While 60-66% of active managers have failed to meet or exceed their benchmarks in recent years, that leaves over one-third that did. The question is, how do YOU find the successful active managers?

Unfortunately, most investors don’t have access to (or are unwilling to pay for) sophisticated services that track and rank active managers. Many of the most successful active managers don’t advertise widely (they don’t need to), so you’re not likely to hear about them. The average investor’s odds of finding the truly successful active managers are sadly quite low.

Now let’s turn to the most important thing you should understand about passive strategies. As I noted earlier, most passive managers are at or near 100% invested at all times. What this means is that in a market downturn, passive investors are going to experience the whole loss or maybe even more due to fees and expenses.

Put differently, this means that the millions of investors who have herded into passive strategies over the last few years will very likely regret that decision in the next serious downward correction or bear market. Unfortunately, when investors move en masse, it is very often the wrong decision. Think “contrary opinion” theory.

Takeaways From Today’s Active vs. Passive Discussion

The fact is, there are plenty of successful active managers and funds out there. Unfortunately, there are probably twice as many that are mediocre or worse. The question is, do you have the tools to separate the good ones from the bad ones? The answer for most investors is NO.

As an aside, this is exactly the reason I started Halbert Wealth Management in 1995 to help investors identify the successful active managers. Over the last 21 years, we have invested in the expensive ranking services and the sophisticated tools necessary to identify the successful managers and weed-out the under-performers.

The bottom line is, if one can consistently identify the successful active managers, as we believe we can, then there is no question that I would recommend actively-managed strategies over passively-managed strategies.

I’ll take my chances with successful active managers over passive managers that are sure to get clobbered in the next serious downward correction or bear market. The current stampede into passive investments is a mistake in my opinion.

Putting Together Combinations of Active Managers

Even the best active managers will hit a “rough patch” now and then when their investment strategy gets out of sync with the market. For that reason (and others), we always recommend that clients diversify with multiple managers. We assist clients in determining the combination of managers that best suits their financial goals and risk tolerance.

Many of our clients prefer actively-managed strategies that can invest LONG OR SHORT with the potential to profit from a rising or falling stock market. In 2013, we analyzed the universe of active managers that trade long and short, which led to the introduction of our…


The Alpha Advantage Strategy is a combination of professional active managers who trade both long and short (as market conditions warrant). Each of these managers today has at least a decade of actual trading of their proprietary systems.

The beauty of the Alpha Advantage Strategy is that you can access this combination of successful active managers in one account at one custodian (Guggenheim) for a minimum of $50,000. You instantly have a level of diversification with multiple successful long/short strategies.

So how has it done, you ask?

As of the end of October, Alpha Advantage gained an actual 16.81% in 2016 net of fees and expenses. It was up again in November, but we don’t have final numbers yet. Over the history of this particular combination of managers, dating back over a decade, Alpha Advantage would have gained 18.4% annualized on average net of fees and expenses.

Hypothetical Performance August 2005 - January 2014
Actual Performance February 2014 - October 2016

Alpha Advantage Performance

The hypothetical portion of the returns shown above is simply the combined historical actual performance of each one of the strategies that make up this portfolio, net of all fees and expenses. As you can see, the numbers are very attractive! 

While there are no guarantees that this combination of managers will always be this successful, their past track record is very impressive.

Best of all, Alpha Advantage would have had less risk, as measured by drawdown. The S&P 500 had a worst drawdown of over 50% during this time period. Alpha Advantage’s worst drawdown would have been only -16.8%.

And here’s the most surprising part: Alpha Advantage not only would have made money in 2008, it was the best year in the program’s hypothetical track record. And who isn’t looking for a strategy that actually would have made money in 2008 when everything else got clobbered?

As always, I must remind you that past performance is not necessarily indicative of future results. Also, the performance illustrated above must be considered hypothetical until January 2014 because, to our knowledge, no one had money invested with this specific combination of strategies during the time period shown.

Action To Take: At this point, I must assume you agree with me that carefully selected active management strategies are preferable to passive index investing, which will get clobbered in the next bear market. If so, I encourage you to take a CLOSER LOOK at our Alpha Advantage Strategy.

Call us today at 800-348-3601 with any questions, or if you would like more information, including the application and forms to open your account at Guggenheim in this exciting multi-manager program.

Wishing you profits,

Gary D. Halbert


IMPORTANT NOTES: Halbert Wealth Management, Inc. (HWM) and Scotia Partners, Ltd. (SPL) are Investment Advisors registered with the SEC and/or their respective states. Information in this report is taken from sources believed reliable but its accuracy cannot be guaranteed. Any opinions stated are intended as general observations, not specific or personal investment advice. Investments mentioned involve risk, and not all investments mentioned herein are appropriate for all investors. HWM receives compensation from SPL in exchange for introducing client accounts. For more information on HWM or SPL, please consult Form ADV Part 2, available at no charge upon request. Officers, employees, and affiliates of HWM may have investments managed by the Advisors discussed herein or others.

As a benchmark for comparison, the Standard & Poor's 500 Stock Index (which includes dividends) was used. It represents an unmanaged, passive buy-and-hold approach, and is designed to represent a specific market. The volatility and investment characteristics of this Index may differ materially (more or less) from that of this trading program since it is an unmanaged Index which cannot be invested in directly. The performance of the S&P 500 Stock Index is not meant to imply that investors should consider an investment in this trading program, which is actively managed, as comparable to an investment in the “blue chip” stocks that comprise the S&P 500 Stock Index.

The performance from inception through January 31, 2014 is hypothetical performance provided by SPL that was constructed using the actual performance numbers of multiple strategies used in this program, assuming approximately equal initial allocations to each strategy. The amounts allocated to each strategy were rebalanced as the individual strategies move back into the cash position. The hypothetical performance was reduced by the maximum annual fee of 2.5% on the first calendar day of each quarter. From February 1, 2014 forward, the performance is from an actual account traded using the same strategy used in the hypothetical track record. The maximum fee (2.5%) was deducted from the account, though not necessarily on the first calendar day of the quarter.

This combined performance illustration through January 31, 2014 is hypothetical and not model results, and has many inherent limitations. The limitations include: 1) there are often large differences between hypothetical performance results and the actual trading results achieved by a particular program; 2) hypothetical performance results are prepared with the benefit of hindsight; 3) hypothetical results may not reflect the impact that market or economic factors might have had on the investment methods if actual money was invested; 4) hypothetical returns do not reflect the actual performance of an account and may not be indicative of the Advisors’ ability to manage money; 5) other clients may have had materially different investment results; and 6) these numbers should not be used to predict future performance.

The performance numbers provided by SPL have not been verified by HWM, and therefore HWM is not responsible for their accuracy. Statistics for “Worst Drawdown” are calculated as of month-end. Drawdowns within a month may have been greater. PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. Mutual funds carry their own expenses which are outlined in the fund’s prospectus. An account with any Advisor is not a bank account and is not guaranteed by FDIC or any other governmental agency.

When reviewing past performance records, it is important to note that different accounts, even though they are traded pursuant to the same strategy, can have varying results. The reasons for this include: i) the period of time in which the accounts are active; ii) the timing of contributions and withdrawals; iii) the account size; iv) the minimum investment requirements and/or withdrawal restrictions; and v) the rate of brokerage commissions and transaction fees charged to an account. There can be no assurance that an account opened by any person will achieve performance returns similar to those provided herein for accounts traded pursuant to the Alpha Advantage program.

In addition, you should be aware that (i) the Alpha Advantage program is speculative and involves a high degree of risk; (ii) the Alpha Advantage program’s performance may be volatile; (iii) an investor could lose all or a substantial amount of his or her investment in the program; (iv) Scotia Partners, Ltd. will have trading authority over an investor’s account and the use of a single program could mean lack of diversification and consequently higher risk; and (v) the Alpha Advantage program’s fees and expenses (if any) will reduce an investor’s trading profits, or increase any trading losses.

Returns illustrated are net of underlying mutual fund management fees, and other fund expenses such as 12b-1 fees. Management fees are deducted quarterly, and are not accrued on a month-by-month basis. They do not include the effect of annual IRA fees or mutual fund sales charges, if applicable. The program trades frequently and most gains or losses will be short-term in nature. No adjustment has been made for income tax liability. Consult your tax advisor. “Annualized” returns take into account compounding of earnings over the course of an investment’s actual track record. Dividends and capital gains have been reinvested. Money market funds are not bank accounts, do not carry deposit insurance, and do involve risk of loss. The results shown are for a limited time period and may not be representative of the results that would be achieved over a full market cycle or in different economic and market environments.


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Forecasts & Trends E-Letter is published by Halbert Wealth Management, Inc. Gary D. Halbert is the president and CEO of Halbert Wealth Management, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, Halbert Wealth Management, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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