May 09, 2021

Absent information about the managers skill set, the risk of selecting a less skilled manager is high, an unacceptable risk for many investors. For them, the passive strategy is the safest option. An outcome that fits with our investment philosophy. We believe that the first obligation of an investment manager is to be average. While this may sound strange, there is a rationale for this recommendation. Buying the index has consistently outperformed most of its peers and as we mentioned on a cap weighted based, the index ranks at the 50% level. Thus, buying the index funds ensures that the investor is at the 50% rank, i.e., average. The next step in the investment process is to look for skilled managers that consistently beat their benchmark. Again, those managers do exist. The question is how much of one’s funds should be allocated to the passive strategy and how much should be allocated to the active strategies. To us the answer depends on the assessment of the likelihood that the active managers will outperform the benchmark. If the manager has skills, then dabbling in active management could be very fruitful as the asset weighted returns. We suggest increasing the exposure to the active managers in direct proportion to their likelihood of being above or below average. Another issue to take into consideration is whether there is any cyclicality to the out or under performance. If there is, then the investment strategies allocating to passive and active strategies should not static.

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