We get inundated by research, which compares active management - managers who try beat a certain benchmark - against passive management - managers who try to mimic a certain benchmark.
Most of the research presents a compelling conclusion for the use of all passive or all active managers. However, after a good hard look, the evidence that supports such claims is highly skewed. In my opinion, "There are three kinds of lies: lies, damned lies, and statistics." It’s easy to make the case for passive or active when you cherry pick the data. The reality is that there are sound reasons to use each.
I do find a compelling case to put one kind of management at the bottom of the list – the closet indexer. The closet indexer is a manager who is classified as active, but in fact holds a lot of stocks, keeps sector weightings close to that of his or her benchmark, and/or rarely deviates from the benchmark. There is no reason to pay active management fees, which are higher than passive management fees, for someone who by and large will perform relatively close to the index.
That isn’t to say I want my active managers taking an inordinate amount risk. However, I do want them to earn their fees by doing diligent research, creating value, and beating the index over a full market cycle. If an active manager simply owns the same securities in the same weighting as the index, he or she can’t beat it.
