Executive Summary
The debate about which is better - passive versus active investing - has been around for a long time. But in a world of pooled investment vehicles, especially with such a breadth of mutual funds and exchange-traded funds (ETFs), there are technically two levels on which decisions must be made: within the funds, and amongst the funds. Consequently, to describe the approach of an investment advisor, we should ultimately describe the process at both levels, to make clearer distinctions. For instance, are you strategically passive, or would strategically active be a better description. Wait, strategically active? What does THAT mean!?
The inspiration for today's blog post comes from a series of discussions I've been having with several planners, including Ken Solow, the Chief Investment Officer at Pinnacle Advisory Group, about how to classify and characterize various investment approaches that financial planners are using today. Most of the confusion seems to lie in the reality that investment decisions now often occur at two levels - at least where pooled fund investments are concerned - but we rarely make a distinction between the two.
In the "old traditional" world, there were two pretty clear camps: you were either active and bought stocks and bonds (or actively managed mutual funds that bought those things), or you were passive and held index investments (such as mutual funds from a company like Vanguard early on, perhaps an S&P 500 ETF like the SPY from State Street more recently). The line between active and passive was relatively clear.
Now, however, the line isn't as clear. Imagine you are looking at a client's statement from another advisor, and see a broad array of ETF index funds. In the classic world, this client's advisor would 'clearly' be implementing a passive, strategic buy-and-hold investment process. But what if the advisor is actually an active, tactical asset allocator, who is simply implementing the tactical process by making shifts using index ETFs to gain the requisite asset class exposures? The advisor is tactical and active amongst funds, even while the funds themselves are passively constructed. Now you might want to call that tactical asset allocation or you might label it "market timing", but either way it seems clear that a portfolio full of passive index funds doesn't necessarily mean you're purely passive, anymore!
Similarly, some advisors seem to characterize themselves as being strategic buy-and-hold investors who just rebalance periodically... yet the underlying funds they hold may be actively managed mutual funds which themselves change investment holdings. So if your portfolio composition amongst the funds is determined strategically, is bought-and-held, and only altered due to rebalancing, does that mean you're strategic and passive? Or if you buy active funds, does that mean you're still active?
How does all of this get clarified? By classifying an approach at two levels: how the planner invests amongst funds, and how the funds themselves are invested. Thus, one might be tactical with passive funds, tactical with active funds, strategic with passive funds, or strategic with active funds. Four different ways to implement an investment process. Rather than 'just' using the active and passive labels, the description needs to go deeper to capture what happens at both levels: passive versus active holdings, and strategic versus tactical implementation of those holdings.
So what do you think? How would you characterize your investment process? Is this a useful way to make distinctions amongst the ways that portfolios can be implemented?
