Yesterday, we mentioned an unreleased academic study that measured the aggregate “cost of active management” in US equity markets. We concluded with remarks from one particularly staunch proponent of efficient markets. But even he left the door open for active management (presumably where markets were less efficient).
Assembling such an active/passive portfolio lies at the heart of alpha/beta separation. But since the term “alpha beta separation” conjures up memories of high school math club, marketers of asset management services have coined the term “core/satellite” investing (where “core”=passive and “satellite”=active). What’s striking is that, rather than being ridiculed by traditional passive managers, core satellite is being embraced by them.
For example, this brochure from Barclays (iShares) is subtitled “creating harmony between index and active strategies”. It says:
“Core/satellite investing is an established investment strategy with many variations. At its essence, the strategy combines ‘core,’ or diversifying asset class investments, with ‘satellites’ that seek outperformance. Unlike traditional core/satellite strategies, which rely exclusively on actively managed products as both the core and satellite, today’s core/satellite models combine index and active investments across asset classesâ€”creating a balance between a strong foundation based on diversified asset allocation and opportunities for risk-controlled, enhanced performance.”
Institutional investors will recognize the message in this brochure as an active overlay on a fixed “policy mix”.
Vanguard, the bastion of passive management, also embraces core satellite investing. This marketing piece, “The Benefits of Active-Passive Combinations” says:
“Indexing and active management may seem like opposite sides in a debate. For some investors, if one strategy is right, the other must be wrong. In reality, combining the two very different approaches to portfolio construction can add value.”
“‘Indexing and active management are not necessarily mutually exclusive,’ said Don Bennyhoff, investment analyst at Vanguard Investment Counseling & Research. ‘Many investors may be better off with all-index portfolios, particularly in taxable accounts. But there will be some who might prefer an opportunity to outperform, without the potentially higher costs and risks that are associated with all-active portfolios.'”
Vanguard puts a decidedly behavioral spin on the search for alpha that is reminiscent of a debate between Peter Bernstein and James Montier last year (see related posting).
“As long as investors make behavioral and informational errors, there will be opportunities to outperform the market. Many investing decisions are emotionally driven. On any given day, investors may underreact or overreact to news, trading securities at prices unequal to their real values.”
This, from a traditional advocate of passive investing. Aren’t proponents of active and passive investing supposed to hate each other? It now seems that active managers might want to ask themselves “who needs friends when you’ve got enemies like these?”