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By Jason Stipp | 09-18-2014 04:30 PM

Dickson: Active or Passive, the Key Is Costs

Investors can succeed with active, passive, or a mix of both kinds of funds--so long as they mind the fees, says Vanguard's Joel Dickson.

Jason Stipp: I'm Jason Stipp for Morningstar. As the active and passive debate continues abated, investors may wonder just which camp they should fall into. I am here with Joel Dickson of Vanguard to offer some insights on active versus passive investing from Vanguard's point of view.

Joel, thanks for joining me.

Joel Dickson: It's great to be here, Jason.

Stipp: The debate between active and passive is as fervent as ever. Vanguard offers index funds--you're known for your index funds. You also offer active funds. We have Medalist ratings on both types of funds at Vanguard. So, from Vanguard's perspective, why do you have the active funds? What role do they fill in your product lineup?

Dickson: Actually, it's funny; Vanguard started as an active-management shop back in the early 1970s. And over time, while there have been more passive assets as we've grown, still about 40% of our total assets are in active strategies in various forms. And really, the passive-active distinction is more about cost than it is about the intelligence or randomness of active management. It's about cost.

And all else equal, lower cost means the shareholder or the investor keeps more for themselves. And that's true whether you're talking about an active strategy or a passive strategy, and minimizing the cost gives you the best chance for success over time.

Stipp: So, whether you are going active or passive, keep an eye on that expense ratio. Is there any philosophy at Vanguard that says we would be more likely to have an active fund in this area of the market and we would be more likely to have index products in this area of the market?

Dickson: It's funny because a lot of times you'll get people thinking that less efficient markets mean a better chance for active management is usually the way that it goes. Our view of it is really much more of the fact that the zero-sum game holds in all markets, whether it's efficient or not efficient. If an investor has bought a security, somebody else sold it to them. And so, you have a winner and a loser on each side. And in aggregate then, you're going to get the market return. And if you can minimize costs, that means you have a better chance of outperforming with that zero-sum game in place.

So, when we talk about [active and passive] in portfolio construction, it is a little bit more about whether you as an investor really do have a belief in an approach of a particular asset manager or active approach. And if so, then maybe what you do is, regardless of whether that might be in large-cap growth stocks or small-cap emerging-market stocks, where you believe you have a manager who can provide some sort of performance advantage for you, whether it's risk or return, use that manager and then build around that with passive. So, basically using it as satellites, those active, wherever you find you have the most conviction.

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