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The Pitfalls of the Passive Investing Marketing Pitch

Here’s a crazy headline from Reuters this morning:

Largest exodus in five years hits U.S.-based stock mutual funds: ICI

This is what most people will describe as the migration from “active” to “passive”. In other words, index funds are taking the place of more active stock picking funds. Of course, regular readers know there’s no such thing as passive investing.  And this debate is front and center in the context of this exodus into index funds because all index funds are not what they might claim.

As an example, I was perusing Twitter this afternoon when the very excellent Jeffrey Ptak highlighted this new fund offering:

When you open the Prospectus we find the following description:

Principal Investment Strategies of the Fund
The Fund is a “fund of funds” that employs a “passive management”—or indexing—investment approach designed to track the performance of the Index. The rules-based Index measures the performance of a diversified portfolio of exchange traded funds (“ETFs”) representing common global equity, fixed income, and cash asset classes.

Uh oh. There it is. That word, “passive”. So, what we have here is a fund that will employ a tactical strategy (read, higher turnover than a traditional index fund) inside a wrapper that costs 1.06% (more than 1% higher than the lowest cost index funds).  This is active management by another name! What’s now happening is that all of these funds that traditionally got wrapped in mutual funds are now being wrapped in ETFs. And because an ETF tracks its own internal “index” it can call itself “passive”. So, we have assets flowing from “active” mutual funds into “passive” ETFs that are actually active strategies charging high fees.

As I’ve long been saying, you have to be really careful about how you allocate your assets in this new world where the term “passive” investing has lost its meaning.¹ We want to believe that “passive” is good and “active” is bad, but the line has been blurred. The term passive has lost its meaning to the point where it’s now a useless concept.

Conclusion: I say keep it simple. Refer to everything as active and study these different products on their actual merits and not the marketing pitches that the media and the fund companies use to oversimplify their descriptions.  This will help you avoid many of the pitfalls when allocating your savings.

¹ – See, The Myth of Passive Investing