Larry Swedroe, the research director at St. Louis-based Buckingham Asset Management, just had his book, "The Quest for Alpha: The Holy Grail of Investing," published. It's his 10th and it's not to be missed. It's as concise and trenchant an indictment of active management as you'll ever find.
When IndexUniverse.com Managing Editor Olivier Ludwig caught up with Swedroe recently, they talked about the active vs. passive debate and how Swedroe came to be such a passionate advocate of passive investing.
Ludwig: You talk about it in your book, but why the persistence of any sort of discussion in the active vs. passive debate, when the numbers seem so persuasive?
Swedroe: Because it's simply not in Wall Street's interest, because they wouldn't be able to charge you big fees for active management anymore and because you can obviously run a passive fund much more cheaply. And also, you'd have to compete with Vanguard, DFA and others.
And the media needs you to tune in to hear what's the best stock to buy and which funds are hot, etc. So they're not going to tell you that passive investing is the winning strategy
So it's really a question of whose interest these people have at heart. It's very hard to convince somebody that they're wrong when their economic interests are in the opposite direction. They just go through "¦ I think psychologists call it "cognitive dissidence."
It was Demosthenes who warned us that what each man wishes he also believes to be true. And Upton Sinclair, on the subject, said: "It's amazing how difficult it is for a man to understand something if he's paid a small fortune not to understand."
Ludwig: How did you come to this insight that passive investing was the sensible way to go?
Swedroe: Well, it's an interesting journey. I ran trading rooms for Citicorp, a foreign-exchange operation. I was responsible at Prudential Home Mortgage for hedging of our mortgage assets and interest rates. I also used to sell economic forecasts for Citicorp. I would go around the country talking about our economic forecasts, and sell them and technical analysis models to major corporations. I was a trained economist, so when I got a forecast right, of course I took credit for it.
And when I got it wrong, what did I do? Well, it wasn't my bad analysis; I blamed some unexpected event that nobody could have forecasted. At the end of the day, if you do that, you're a genius because you're never wrong. You're just unlucky on occasion. And overwhelmingly over time, I became convinced from reading all of the academic literature that this is a clear-cut case of the idea that "there's no army strong enough to withstand an idea whose time has come."
To me, the evidence is so overwhelming, that, while it's not impossible to beat the market, it's certain that so few people will succeed that it's not worth trying. And there's no way for you to identify these people ahead of time. The best evidence of that is looking at the performance, I think, of pension plans. Goldman Sachs has a consulting unit, and they did a study on pension plans. And they admitted that the overwhelming evidence is that pension plans are wasting money for active management.
That's Goldman Sachs! And of course, Goldman Sachs sells advice to pension plans and sells their funds. Now, it doesn't mean that there aren't people who are always finding little inefficiencies and exploiting them.
The market, I would say, is always moving towards more efficiency. So you'll find somebody who discovers an anomaly. So they can go and exploit it. But the very act of exploiting it makes the anomaly go away. That's what killed Long-Term Capital Management, right?
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