We are at a point in the market cycle where passive investing has become significantly overdone, and as a result, small, disciplined, active managers now have a distinct competitive advantage over their larger, index-shackled bethren. We understand that we need to make a persuasive case for active fees, which can be double the cost of many ETFs, or more. Do active managers deserve these fees? Is it possible to replicate their portfolios given the plentitude of industry and country-specific ETFs available to the average investor today? We would argue that active strategies cannot be effectively replicated using passive vehicles, and that an active management strategy adds a layer of benefit not present in passive investing.
During this strange era in which we live, many of us long for the return of live entertainment. We can only hope that neither entertainment nor investing has been permanently handed off to the virtual world of computers and algorithms. One of our analysts, a sports fan, drew the following interesting analogy. Most people only know Branch Rickey as the general manager of the Brooklyn Dodgers, whose promotion of Jackie Robinson into the Major Leagues broke the color barrier. This act of courage and historic vision was clearly his crowning achievement. But an overlooked facet of Rickey’s career was his creation of the Minor Leagues, or farm system, in the 1920s as general manager of the St. Louis Cardinals.
Baseball fans know that having a strong farm system is key to the prolonged success of a Major League team. The Cardinals were a small market team incapable of spending large sums of money to acquire talent like the big, bad Yankees. Rickey realized that if he could acquire many players at a young age before they reached their potential, some of them would inevitably become superstars, producing huge returns on his investments. He created tryout camps all over the country with Minor League teams serving as local liaisons, as a quick and inexpensive means of finding young promising players. Success came very quickly; the Cardinals won many pennants and the World Series during Rickey’s time. But Rickey’s active decision-making did not stop there. He developed many players internally, always keeping new and exciting prospects in the pipeline. Controversially, he also traded or sold superstars as they finished their prime and offered diminishing returns. “Trade a player a year too early rather than a year too late,” was his motto. Hall of Famers Dizzy Dean and Johnny Mize are examples of players developed internally who were traded or sold just prior to a rapid decline in performance.
The Active Investing “Ball Game”
Rickey’s active, deeply researched style is akin to what true active investment managers employ on behalf of clients. As the growth of passive investing and “closet indexing” has exploded over the past decade, an…