Many articles are starting to surface acknowledging and critiquing the groundswell movement to passive investment strategies and near-wholesale movement to Exchange Traded Fund (ETF) investing. Several of these articles take the position that this portends doom of one type or another. For the reader's edification, passive strategies are generally mutual fund or managed account investment services where the mandate of the strategy is to match the holdings of a benchmark, like the S&P 500, versus a typical active strategy of picking stocks. The ultimate active manager is typically a hedge fund, so it's no wonder that the threat of low-cost passive investing has raised a few of their hackles, since typical hedge fund fees are many multiples higher. Passive strategies are often accessed via ETFs. Due primarily to lower costs, ETFs have an impressive track record of beating their active brethren; but there are also tax benefits to ETFs as well. Since active managers view this trend as a threat to their livelihood, understandably not everyone is a fan. Will Rogers once said, "Don't expect a man to understand a fact, when his job is based on him not understanding it."
Segment has been a big proponent of such passive strategies since the firm was founded in 2010. I had followed a similar playbook at UBS before, culminating in many heated arguments with the firm's leaders, and defending my rights to build portfolios with a passive methodology. After they acquiesced, this resulted in me being selected as one of six advisors in the country allowed to "experiment" with 100% ETF portfolios starting in January 2003. The success of this program partially contributed to my leaving UBS to form Segment because this freed me from having to eat the "firm's cooking." That is also the likely reason that UBS had so vehemently opposed me constructing client accounts this way. They much prefer the use of active strategies, where client fees can run many times higher, and where advisors hand off part of the control of client accounts to the active managers. Maintaining advisor control of client account holdings makes the brokerages vulnerable to advisor departures since this often makes the advisor nearly irreplaceable to the client.
A client recently sent me an article written about the possible market problems conceivably created with ETFs. It was written by Dan Denning, for investment newsletter pioneer, Bill Bonner. The 20-page newsletter generally blasts passive investing and ETFs specifically. Some of the claims varied from partially accurate to outright fallacy. I read the first half with great interest, and skimmed the remainder. I tend to find more insight between the lines than the information in them. I envisioned newsletter subscriptions in steep decline and the author's hackles up, since investors are losing interest in stock ideas and ETF companies don't generally subscribe to newsletters. ETFs may be biting Mr. Denning (Bonner et al) in his pocketbook. As investors lose interest in stock picking advice, ETFs can make even more sense because one can express virtually any investment bias or opinion with a basket of securities down to individual industries like aerospace or internet infrastructure. This "basketization" tends to provide several positive buffers for the client: mitigation of individual security risk, and reduced hassles of voting and reporting requirements; all resulting in lowered client anxiety.
