Do passive investments really score the best compared to those active managers within their category? And is it sound to simply pick one fund family for your beta exposure?
They’re two important questions asked and answered by LeafHouse Financial in a new whitepaper released at their annual retirement symposium this week in Austin, Texas. It tackles the ongoing “taste great/less filling” debate over active versus passive strategies within the portfolio.
As the authors note, passive investing has seen asset flows increase over the past decade. Index funds comprise 27% of the market share relative to active managers. Much of the time, analysts, who employ scoring and rating systems, give passive investments the highest possible rank.
The paper describes the LeafHouse Grade Point Average (LeafHouse GPA) algorithm and technology, which evaluates over 150,000 active and passive funds by incorporating:
- Performance
- risk/reward
- fees, and
- other qualitative/quantitative measurements,
It then compared these data points on a peer-to-peer basis within each category.
“Limiting your investment selection by a single brand name is no longer a best practice.”
LeafHouse Financial
“The answer to question No. 1 is clear,” the paper argues. “Passive should not get a pass simply because they have low tracking error. That mentality would be the same as saying a fund manager wants to consistently perform in the 3rd quartile every quarter, and they do it consistently; thus, we will score them at the top of the class. Investment volatility matters, and category selection matters.”
The answer to question No. 2 becomes obvious when one sees that “relative to all peers, both active and passive, no one fund family has the best scoring GPA for every category index. Limiting your investment selection by a single brand name is no longer a best practice.”
Ultimately, LeafHouse concludes that investment research is the fuel that drives methodology and improvements to that methodology.
“This is not the first time we have improved our GPA algorithm, and it will not be the last. Whether you support the assertion that active managers can provide alpha or believe that index funds are the way to go, the due diligence and investment research process should be similar. We believe there is a place for active and passive, but there will be no more free rides for index funds with low tracking error.”