Good reads from around the Web.

Even as passive investing in index funds stealthily takes over the investing world, the media and many investing professionals still seem in denial, if not downright hostile.

Perhaps I shouldn’t complain.

Every Saturday morning I review the investing links I’ve found in the previous 6-7 days that have any relevance to UK readers. Often – like today – the passive haul is about as bountiful as you’d get if you drift-netted the Dead Sea.

For now at least, the role for Monevator on the Web seems intact. That’s personally reassuring given seven years of Saturday morning link-compilations and all the writing we do in-between, but I’m not sure it’s good for investors.

For example, one UK blogger said the only place he saw the news that Vanguard had cut its charges on UK ETFs was here on Monevator.

He wasn’t right about that, a quick Google Search reveals. It’s true though that the news wasn’t exactly flashed in lights. The Telegraph even managed to find a negative spin, with a headline warning of a catch. Platform charges could be a sting in the tail, the article went on.

Fair enough, but why is that headline news when it’s equally true of all funds?

Up denial river

It has been interesting watching the criticisms of passive investing evolve over the years since the idea was introduced by John Bogle in the 1970s.

First it was ridiculed, and then decried as unworkable.

When index trackers proved totally workable, detractors started championing the superiority of active managers – even as the threat of passive funds and the difficulty of consistently beating a benchmark turned many of them into closet trackers.

Becoming desperate, some have called passive investing “un-American”. Presumably the idea is it’s better to reach for glory and fail – in the spirit of the American Dream – than to settle for average. Rather like a beautiful young person who goes to Hollywood to become a star and ends up a stripper and in later life a bag packer at Walmart. At least they lived their dream, right?

Actually, I have some sympathy for that view when it comes to business, art, sport, and becoming the next Isaac Newton.

However I don’t believe many young people’s burning ambition is to enrich the financial services industry by paying high charges.

Another tack that’s been gaining ground this year has been to simply declare the active versus passive debate ‘boring’.

I admit that hurts, though I suppose we’re biased here on Monevator.

If anyone is an indexing trainspotter it’s my co-blogger, and I know that some of you would be happy to stand beside him at passive investing’s metaphorical Clapham Junction.

When you’re wrong, even when you’re right

Another new tack was taken this week, in a rather strange article from Cullen Roche at Pragmatic Capitalism.

Roche constructs what’s in my opinion a straw man argument that says passive investing must – by his definition – involve buying the global market exactly as you find it, with the same weighting towards equities and bonds.

He then argues that since this is impossible, passive investing (by his definition) is impossible, and adds that those of us who advocate passive investing likely “don’t understand there is no such thing.”

He presents no evidence for the latter point, he just declares it.

Roche also implies that anyone who did passively invest to exactly mirror the global market – again, his definition of passive investing, remember, which he has already implicitly conceded nobody does because he’s already told us it’s impossible – would basically be an idiot, because sometimes assets prove to be overvalued.

He cites a few active managers who took a stand about some asset or another and were right and says that’s why they’re on a pedestal.

“What’s rational about being overweight bonds after the biggest bull market in history?” he asks.

I don’t know, most passive portfolios don’t advocate that so I’ve never looked into it. Only his phantasmagorical version does.

Theory versus reality

I am in no way personally attacking Roche here, just the thrust of this piece. In fact I’ve linked to other articles of his in the past, and if you ignore the screeds about “this ‘passive’ investing ideology”, you might find even this article a thought-provoking read.

It’s that tone I don’t get. I really don’t understand why he’s running around in circles to lambast something that he’s just invented as a problem.

I also disagree with his implication that since some managers could do better than the passive approach, passive investing has a big weakness as a strategy.

That isn’t the point. The reality is vanishingly few managers do better, even if the efficient market hypothesis leaves sufficient room to make outperformance possible.

Given that, why should investors choose active funds if they want the best chance of appropriate returns?

There’s no logic. They are not investing to support careers in the financial services industry, or to play some great game of finding a needle in a haystack. They just want the best odds of a decent return.

You see this time and time again. Fund managers and platform spokespeople saying passive investing is all very well, but some manager beat the benchmark last year or last decade or whenever, so choose them.

It’s a fallacy if what you’re after is the likeliest shot at near-market returns.

Know what you’re doing and why

None of this is to say I am against investing in active funds if you’re prepared to do worse for a chance to do better.

Equally, I am right behind you if you want to stock pick your own portfolio.

I do, and for now I wouldn’t have it any other way. That’s the great irony of this website (and why my co-blogger writes most of the passive articles!)

But my personal preferences are no argument against passive investing. Nor is a complaint about the word ‘passive’, nor is the fact that one in a 100 fund managers (or one in 50 or one in a 1,000 – it really makes no difference to the logic unless it were one in two or so) beats the market for long enough for it not to be a fluke.

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The pension and fund management industry tries to get us to focus on performance – not costs – when it comes to investing.

This is pretty ironic, given that most fund managers actually under-perform a simple tracker fund.

Indeed, in its first video on the case for passive investing in index funds, Sensible Investing quoted research that found that merely 1% of fund managers showed any evidence of skill that might be worth charging for.

In 99% of cases, there was no skill on show at all. Given this, performance is clearly a distracting sideshow.

High costs pull down the returns you see from active funds. They simply enrich the industry at the expense of your pension.

Worse, most investors have no idea what they’re actually paying for, as outlined in this second video:

Gina Miller of The True and Fair Campaign – which pushes for fairer, more transparent investing – estimates that there can be 11-13 layers of charges applied to your pension.

And as Nobel Prize-winning economist Eugene Fama says:

“If you’re paying management fees, the cumulative effect of that, given the way compounding works, is enormous. So active managers basically charge on average 1% in the US on management fees and you never know what their transactions costs are because that’s not a reported number but they’ve gotta be way higher than for passive managers because they’re going in and out of securities all the time.”

Instead of the red herring of chasing performance, you’re much better off drilling down the costs you pay to make your investments – including the charges levied by your broker or fund platform.

Check out the rest of the videos in this series so far.

You may have already seen the first part of the upcoming 10-part documentary on passive investing by Sensible Investing, as I featured it in Saturday’s Weekend Reading.

I think the rest of this series looks very promising. There’s a roster of high quality interviewees to come and the videos make the case for index funds versus active fund management in a down-to-earth fashion.

So I’ve decided to run all the videos as they appear here on Monevator.

You’ll find part one in the video series – entitled How to Win the Loser’s Game – below. Please note that if you’re reading via email you may need to visit Monevator to see the video.

Perhaps the killer line in this video is the revelation that one single fund manager was paid £17.5 million in 2013.

That’s 600 times the average UK salary!

Of course the high costs spread far wider than just one person. Indeed, at one fund management company surveyed, the average salary was a cool £436,000.

As Lars Kroijer – himself a former hedge fund manager – has previously revealed on Monevator, paying for the high costs of active management hugely reduces just how much the typical investor in active funds will earn over their investing lifetime.

Given the evidence that the average active fund fails to beat the UK market, you must really like fund managers if you want to keep them in sports cars and Mock Tudor mansions at the expense of your own retirement!

Oh, and in case you’re wondering, the title of the video refers to a famous article on the poor odds of active fund management written by Charles D. Ellis in 1975, which he’s updated in his recent book, Winning the Loser’s Game.

Check out the rest of the videos in this series so far.