Passive funds are not a strategy and markets do not reward those funds just because they are large, according to Ariel Investments.
Ariel Investments chief financial officer and portfolio manager of international and global equities, Rupal Bhansali, said passive funds could be a ‘penny-wise, pound-foolish trade’ and that people were treating passive funds like a panacea.
“I have nothing against passive funds but investors have been treating it like a miracle cure. You don’t have to work hard at anything, just put your money to work and it’s low cost so it’s off to the races,” she said.
“If you overpay for something, you’re still going to lose money. So, you can’t just think that passive is an investment strategy. It is an investment vehicle – it’s an index fund – it’s a vehicle.
“The underlying strategy people sign up for, that people don’t realise, is formulaic – just buy the largest market cap stocks by market cap. That’s the underlying strategy.”
Bhansali said there was no validation for that kind of strategy.
“Markets don’t reward you just because you’re big – I’ve never heard of that. What markets reward is any strategy that creates a fair price for security,” she said.
“A fair price is the intrinsic price of a business at which neither buyer nor seller makes a profit or loss when you’re converting an asset into cash and cash into an asset – that’s a fair price and that’s what markets reward.”
Bhansali said markets penalised participants that distorted price and rewarded people that restored fair prices.
“That is why non-consensus investing works because not only do I reduce price distortion I contribute to fair price discovery I get doubly rewarded and that’s your upset victory,” she said.
Bhansali noted that investors needed to start questioning risk as returns did not looked after risk.
“Uniformly what people took away from the Global Financial Crisis was banks were taking on too much risk but when they were making returns everyone loved them whether they were mis-selling or over earning, nobody questions when you’re making money,” she said.
“They don’t ask ‘how are you doing this? What is the risk you’re taking in doing this?’ the risk happens later. So not paying attention to risk is a very big investment mistake.”
