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Beyond the Active-Passive Divide

Christine Benz

Christine Benz: Hi. I'm Christine Benz for, and welcome to our roundtable on getting the most out of active and passive strategies.

I'm happy to say that we've got a great lineup of individuals to help us do a deep dive into this topic.

Mike Breen is here today. Mike is associate director of fund analysis for Morningstar.

Scott Burns is also here. Scott is director of exchange-traded fund, closed-end fund, and alternative fund research for Morningstar.

And last but not least, John Rekenthaler is here. John is vice president of research for Morningstar.

Thank you all for being here.

So, we were thinking that we didn't want to have a cage match here, because I think, we all…

Scott Burns: … Is that because you thought I'd win?

John Rekenthaler: He is the largest; I would bet on him.

Benz: (Laughing) So, I think, we can all agree, though, that there are a lot of shades of gray in this debate. John, I'm hoping you can set the stage by discussing the lay of the land in terms of what the data tell us about active versus indexing strategies. Are you better off just indexing and calling it a day?

Rekenthaler: Yes and no.

I mean, there is no question that when you look out across the fund categories, five-, 10-, 15-year timeframes, because in short timeframes anything can happen. We can talk about that, too, but over the longer term, that for most categories a low-cost index fund is going to outperform most of the active funds.

So, there's 200 active funds in the category. Typically, it depends on the time period and the category, but maybe about two-thirds of the funds will trail a low-cost index. So, that's well known, and that's a clear win for indexing overall. What's less well known though is, it doesn't always work out that way. In fact, very much it often tends not to work that way when you look at where the assets are in the funds.

Fund investors actually do a good job of picking active funds. … This is not only not realized, actually people make an argument against that, but that's not so. People don't pick categories well. They market-time categories and move into hot markets. But within a category, they actually do a good job, a very good job, of picking funds. So, when you look at asset-weighted averages of categories of the active funds, in most cases actually they outperform indexes. I went through…

Benz: How about index funds? Do they outperform the asset-weighted returns of index funds?

Rekenthaler: If they can outperform the indexes, they'll outperform the index funds, as the index funds typically will trail the indexes a little bit due to their drag of expenses. But I went through this 81 categories that have been around for 10 years in our mutual fund universe, and on an asset-weighted basis, the active funds, in about 65 of the categories, the active funds actually outperformed the benchmark index for that category over the 10-year period.

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Burns: I'd put one caveat on that, though. When you do the asset weighting what you end up picking up a lot of is the institutional share classes as well, because that's where the preponderance of the assets are going to be. So, I would want to slice that one more time and … exclude the institutional money. It's really about cost at the end of the day that's getting that kind of improved costs.

Rekenthaler: I agree. It's more refined if you do it at the retail level. On the other hand, this holds true, for example, with muni bonds; there are not institutional muni bond shares, right? But the margin is smaller there.

And yes, it does boil down to cost. What people often forget when they quote index funds cost 20 basis points and active funds cost 150 basis points, people are no longer buying 150-basis-point active funds, with the rare exception. So, the assets tend to be in relatively low-cost funds that are maybe 50, 60, 70 basis points, and there the cost advantage for indexing is much smaller, and it's much easier for active managers to be competitive.

Michael Breen: The other challenge with those asset-weighted returns is, you don't know where the money went. So, we've got our Morningstar Investor Returns, and you will see if you ran the numbers for last decade or 15 years--Russ Kinnel did it in our FundInvestor newsletter--one of the biggest wealth destroyers was the Vanguard 500 Index Fund. So 10% to 20% of the total asset base [seemingly] left at the wrong time. So, it's tempting to think people are doing a bad job with the index, but you don't know if they went to the ETF, so you don't know where that money went to…

Benz: Or total market – total stock market.

Breen: Yeah, exactly. So, if you want to pick your spots and use that as a point to support active, you could kind of cherry pick the data. I mean, [the money] did leave, but you don't know where it went, so it's always hard to make that decision.

Benz: Mike, I want to follow up with you, because you often hear this very compelling data in favor of index funds, but one point that seems to get lost is it doesn't rule out the opportunity to pick an active fund that will outperform, and I know that's an argument…

Breen: Absolutely, and that's why I always find it an interesting argument, because the academic research, most of it is, if you randomly select from all 20,000 share classes of active funds, and I don't know anyone who does that in any endeavor. If you're looking for a restaurant or you're going to buy wine, there are publications that rate wine and characteristics you look for in restaurants. So, I've made the point that if you say there are 50,000 restaurants in Chicago, and the typical one isn't very good, that doesn't make it impossible to find a good restaurant; in fact, it's pretty easy.

So, we've done the research, and it sounds self-serving, but looking at our mutual fund M500 list and the Analyst Picks, you end up with a 75%-80% success rate versus the specific index. And that's even controlling for survivorship bias, because we treat it as a portfolio. So, the question is not how many beat the index, it's how hard is it to find one of those funds that does beat the index. And it looks actually not as hard as some folks make it out to be.

Rekenthaler: Now, Mike, that's a bit of contrarian view these days, right? Because you and I see so much that people give presentations at conferences, where people are paying to hear expert speakers, and expert speakers saying things like past performance is no indication of future performance. It's basically random event when you pick an active fund and so forth. I mean, people state this--and it's printed often--that this is a fact.

Breen: There are multiple factors … so you have low fees, good stewardship, past performance, the quality of the management, etc. So, you have to look at all of those, and they are a little bit squishy. It's the same reason people fixate on fees, because you can mathematically measure it very consistently. So, you say it's predictive. But the hard thing is to isolate the fees out from those other characteristics. On the index side, it's easy because it's fees and there is the index.

So, we tend to find that characteristic of low fees goes with good stewardship, goes with manager experience and manager record, etc., and so to your point, they tend to cluster on the active funds with a whole series of those favorable characteristics, and that's what leads to long-term success. So, it's not easy, but it's not that it's impossible or even that tough to [find good active funds].

Burns: I think, it boils down to edge, right, because if you get into a statistical look of index versus active, as John talked about, the index will always win the argument. I mean, the math just kind of backs that up. The sum of all active managers, form the index, plus or minus fees, and while index funds do charge fees, they are generally quite low. I mean, you can have an 80 basis point S&P 500 fund, it will be worse than an 80 basis point active fund, generally. But most of those S&P 500 type funds are charging in the 7 to 10 basis point range, and that's a very low hurdle for them to cross, and creates that gap, which is a high hurdle for active to cross. So, mathematically, whether you want to rely on that kind of statistical evidence, or you look at it as more a flaw of averages, where we are just randomly picking, but that's not what's really happening. It is your ability and your confidence to be able to select an active manager over the index, and I think that's really the threshold.

I own active managers as well, but I don't own that many of them and I own the ones where I have a high degree of confidence that this will do better than the index, and if I don't have a high degree of confidence that I could pick somebody in there, then I'm better off with the index always, because I've lowered that hurdle. It's not about settling for average. It's about sometimes getting better than average, because those fees skew that average return.

Benz: So, you raised a point that I wanted to get to in this discussion, assuming that you all own or believe in active funds for a component of an investor's portfolio, what are those high conviction active funds for you? John, do you want to start?

Rekenthaler: Well, I'm going to give a completely contrarian answer, because it's a family that's been redeemed most of any family since 2008, and that's American Funds. America Funds, to me, it's really a shocking story. I went and looked through the numbers. EuroPacific Fund is in top 15% of its category over 10 years, has beaten the relevant index. Growth Fund of America, top 33% of its category; I think it's about matched the index after expenses. Balanced Fund, AMCAP Fund, Fundamental Investors, New Economy, … the rest of these are all in the top quintile, a couple of them in the top 10% over a 10-year period. They've all beaten their indexes, and people are selling American funds and buying index funds. Now, you tell me why. I have no idea how that's occurred. There's some story there about communication or expectations or something like that.

Burns: Well, I do think it is part of the communication and the expectation. I also think a lot of it's about the product lineup right now, and especially, when you look at the advisor-sold landscape…

Rekenthaler: …which of course, for American Funds it is their market. They don't go direct [to investors].

Burns: I think, they've got some structural issues in the product that they offer, and I'm not the mutual fund expert, but as advisors are moving away from commission-based to fee-based, if you're a fund complex and you have institutional share class with say $1 million threshold, and then you've got some alphabet soup of share classes that are really different ways of slicing and dicing loads and trailers to pay commission, what you don't have then is a product that a fee-based advisor could use. So, even if they like your strategy and they like the performance, you haven't put forth a vehicle that they can use in their current practice. So, I think that's going to be a challenge for the fund establishment right now. I think, there is a lot of focus on active and passive, and with ETFs getting a lot of the assets, and index funds have continued to grow as well. So, it's not just an ETF story. It is ETFs and passive mutual funds.

Rekenthaler: You are on a different discussion here, right?

Breen: You're on the distribution discussion.

Benz: …which is a valid point, but…

Burns: But you asked, why is it happening …

Rekenthaler: That's true, and you answered.


But I do want to finish up this point … and it may not be practical for some in the audience, because they don't sell direct to investors. But again, I want to return to a point, there is just a tremendous belief this is one of these "facts," that's not a fact, that active managers have done this terrible job and money is going into ETFs and indexing because active managers have been a failure. Well, American Funds has not been a failure--on the equity side, fixed income has been trickier. Fund by fund by fund by fund over the last decade, they have equaled or matched the indexes that they compete against, and they are still getting redeemed. So, okay, there might be reasons for it, but let's not say it's because active managers inevitably lose, and I'm tired of reading it when it's not true. People need to go look through the numbers, and that's just not the case. It's not been the case here. They are not getting redeemed because they can't perform. They are getting redeemed for other reasons. There are some valid reasons for moving to ETFs. You can trade them, the transparency. There are a lot of reasons why you might want to make that change, but it's not because they are not performing.

Benz: So, Scott, I'd like to turn the same question over to you. I know you've mentioned that you like Bill Gross to manage your fixed-income assets. …

Burns: I liked him a lot more five months ago.

Rekenthaler: Until he disliked Treasuries… (laughing)

Burns: Yeah, I'm told that didn't work out. But you can't let a six-month period besmirch such a long track record, although I may be rethinking the allocation a little bit. Another fund that I own in one of my IRAs is [Invesco International Small Company IEGAX]. That's been phenomenal. It generates great returns for me.

Outside of that, I think, those are two of my biggest active holdings and those are areas where I, one, have a lot of confidence in the manager; and two, I think that there is a lot of ability for active managers to add alpha, whether it's from investing acumen or from other things that we can talk about later, but those are two areas of my portfolio where I don't use passive product.

Benz: Mike, I know you are an active stock investor yourself, but in terms of funds that you like that you think really have a good shot at outperforming their benchmarks. What are those names?

Breen: It's hard to do these lists, because you're going from your own personal experience, where I have funds that I've owned for 15 years and they've done exceptionally well, and I also have funds that I covered as an analyst. Here at Morningstar, actually, when you get old, you get a list of good funds [to cover]. So, it's one of the advantages of being older. So, every fund I cover pretty much has beaten the index over time of the 30 or 40 or 50 that I have covered.

In my own portfolio, the longest holdings I've had are Longleaf Partners, Oakmark Select with Bill Nygren here in Chicago, Weitz Partners Value with Wally Weitz, and all of those I've owned for more than 15 years on the active side. Selected American with [manager Chris] Davis, and then a smattering of some other things that have flowed in and out of my wife's 401(k) plan.

Rekenthaler: A lot of value…

Breen: Yeah, that was the value persons. And I don't do allocation or anything like that. I just buy and hold.

So, for me, it's really those characteristics we were talking about earlier. Those aren't the only funds that have them. The same manager, Wally Weitz, founded the firm [Weitz Funds] in '83; he's still there. They run money the same way. You can decide if you are comfortable with it and go from there.

On my own list, there are a lot of little quirky funds that no one even knows about. The Delafield Fund, Westport Select Cap. These are $700 million funds that have been around for 20 years. And they're not the cheapest because they are small, 120 basis points (expenses), and they've all trounced their index pretty well over time with good risk-adjusted returns.

Rekenthaler: You're fishing in a completely different pond than my big mainstream American Funds, right, but there's more than one pond in the industry…

Breen: Absolutely.

Rekenthaler: …that people can be successful in, but that's, I think part of the theme of this discussion, right?

Benz: Right, right. So, Scott, I want to follow up on something you said. You own an international small-cap fund, and you like it because you think that's a good area for managers to add value. I am wondering if maybe, John, you can address whether the data show, are there any pockets of the market where people are better off going with index funds, any areas whether they're better off going active?

Burns: Certainly the data show that. The problem is the data also will show something different, often, five or 10 years later.

Benz: Right.

Burns: This is one of those relatively unstable data points where you'll look at a decade and you'll see, hey, in these categories, the active funds performed relatively well, that's where you should buy active…

Benz: So conventional wisdom is small caps, international, and lately I've been hearing a lot of zeal for active bonds. So, when you look at the data, do you see support for those areas being good places to go active?

Rekenthaler: Not entirely. To an extent. There are several things that are going on when you look at these comparisons of active funds versus index funds. One is performance related. If you are in an area, a portion of the market, where the returns have been very strong, the performance has been strong, the index funds will tend to do well.

Benz: Is that Dunn's Law or whatever they call it?

Rekenthaler: Yeah. I won't get into the names, but…

Burns: Don't get him started.

Rekenthaler: (laughing) Yeah, don't get me started. But actually a gentleman named Steve Dunn, who's an amateur investor, was the first one to notice this and comment on it. Not only are the indexes fully invested, which people know about, but the subtler point is that the pool of active funds is never as pure as the index. If you have a small-value index, everything in there is small-value stocks. Now, when you buy a fund, even if it's called small value, it will be mostly small-value stocks, but it will own some larger-cap stocks, on occasion it'll own some blend or even growth stocks.

So, when you have an area that performs very well, the index is more pure than the active funds, and it tends to outperform. When you have an area that performs very, very poorly, then the index will tend to lag. So, these comparisons are performance-related. As Scott has pointed out, and I'll let him talk about it more, they're also liquidity related. And there is certainly a factor that some areas are easier for professional managers to invest in and then maybe add value. We all know large-cap blend U.S. stock is tricky [for active managers to outperform], although I've shown American Funds can do that reasonably well, too. So, there are a lot of factors that go along. That's why I'm hesitant to say index in these three places and go active in these three places.

Benz: And it's time-period dependent, as you've written about…

Rekenthaler: It's time period dependent, whenever you look at these studies. But let's turn to Scott here, why he likes international small cap.

Breen: It really has more to do with the small cap than the international. So, I keep things a little more simple, and I look at ETFs, at their star ratings. In theory, an ETF that's following a benchmark index should be 3 stars, it should be the average of all the active. But we do see actually a surprising occurrence of 2-star ETFs and 4-star and even 5 and 1 star ETFs. I really think that actually has less information about the ETF itself and really more information about the active management around it. So that tells you that in that category, because there is usually relatively few ETFs compared to all the active managers, right?

Benz: So just to back up, for the purpose of the star rating, you throw ETFs in the same bin with active fund managers that invest in that same category?

Burns: Exactly. So, it's an investible option. So, if it's supposed to be average a benchmark index, in theory, should be average plus or minus fees, when it's 4 stars that means on average you are better off with the passive product in that category; when it's 2 stars on average, you're better off with an active product. So, …

Benz: Or you have been better off?

Burns: Or you have been, I should say, historically. So, where we do see 4-star ETFs quite often are actually large-cap U.S. and international securities; so deep pools, liquid, very efficient markets.

But where passive hasn't been good has been in small caps. It's been in things like junk bonds. It's been in areas, really, when I look at what ties it all together is a liquidity factor. So, when you're dealing with things that aren't as liquid, I think, one, index construction is a lot harder; and two, the active manager is able to add value in the way they buy things, in the way they're rebalancing the portfolio … So, it may not even really be a security-selection type of alpha or outperformance we're picking, but it's really more of a transactional one.

But at end of the day, that is part of the performance. That's part of what you're investing in, whether it's a passive product or an active one. So, when we look at it anecdotally, I think, it's hard to find conviction managers in deep liquid pools. It's a lot easier to just say go with the passive. And when you get down into smaller, less liquid, things like small-cap value or international small cap, it actually, I think, has more to do with the small cap than the international to why the outperformance is as good as it is. So, those are some of the things that we see and look at, and I look at my own portfolio.

Breen: In fact, to tack on the point you were making earlier about the indexes being more pure--that was John. That's the other part that gets lost in the shuffle. You have the theoretical, here is all these indexes that land in different style boxes, and they are pure, but what's happening now is you're off-loading the allocation decision to the individual or the advisor, where a fund like Longleaf that I mentioned, or Bill Nygren, they move around the style box, so the managers making the decision of where he is finding value, so you're getting that style change, and at least there is a record proven in the case of those managers that they can do it. So, now the great unknown to me is that you have all these niche indexes that perfectly replicate some section of the market and then you mathematically look backwards, and say, well, they've outperformed most of the active funds, but that doesn't necessarily mean that folks going forward are going to be able to tactically mix them together ahead of the curve before that asset class goes up. So, that's the unknown question for me.

Burns: So, I actually look at those managers in probably a different perspective--that they are kind of a menace, right, because … if you've got an asset allocation strategy, and I think there's a lot of good academic research out there that says whether you're buying stocks or bonds is much more important than who you pick to buy those stocks and bonds, whether passive or active. When you've got your allocation, if you get these style box wanderers, what they do is wreck havoc with that allocation. So, you get this situation where you've got high manager conviction, then you've got an allocation plan, and now they are not meshing anymore.

Benz: But the research about asset allocation really doesn't get into style box drift, right?

Burns: But you know, that is part of the efficient frontier. If you think you want to put in a little more small cap and things like that. If you've got people that are wandering around… The other problem is if you build a portfolio of folks that are wandering all over the place, what I think the real risk that you get is that they all decide there's value in one place, like say financials in 2008. And now, unwittingly your diversified portfolio has become very concentrated on you, right? And maybe you want that, maybe you agree with all them, you totally back it up. But from a risk perspective, that's really not a good way to run a diversified portfolio.

Rekenthaler: It's not, unless they're using Morningstar materials to track where they are. But absolutely, there is quite a bit more--you are right--information work associated with the active strategy. Now Mike has been content. He just buys his managers …

Benz: Buys all value all the time …

Rekenthaler: … Right, and he could be 92% in financials, and he is happy with it.

Breen: I don't even know (laughing).

Rekenthaler: Right. But most of us we would want to do some work …

Benz: Use that X-Ray tool, see where it stands.

Rekenthaler: As Scott has been saying and say wait a moment, I have trusted my managers, but they all have moved in, they're 42% in financials, and it's my call as to whether I want to take that much risk and maybe I don't. I probably don't to tell you the truth, but he does he is braver.

Breen: Well, I look at it very closely at the holdings, because I do my own equity investing, and to me the difference between statistical risk or beta or downside, and the permanent loss of capital are two different things. So, I actually get more confident about an active manager when they are having their worst stretch ever and their long-term record is still intact. So, Bill Nygren and Weitz, who I both owned effectively pre-crash, they were negative in 2007, and everyone else was positive, so they're 99th in their category, their three-year record got torpedoed. Nygren had WaMu, 14% of assets basically went bust, and the long-term record, which I had been in the fund since inception, was still in the top 15%, 20% in the category. I said, well, obviously, this is not a mortal wound, it's something they can survive, and that gave me more confidence, as maybe this is a time to look at what else they are buying and put more money in.

So, you go fast forward three years. Those guys who had the worst three-year record then, Weitz and Oakmark out of my funds, have the best three years. They are top, number-one in their category. So, it's a little bit of a leap of faith, but if you have a pool of them, I don't think it's that hard to do, and you are looking at the holdings and just trying to determine what's a fatal wound and changes their funds' record but also indicates a loss of ability, and what's just sort of a temporary issue.

Benz: What are those red flags, Mike, because I think people wrestle with that? They see a fund, they liked it before. It really hits the skids as several of our favorite funds did. How do you know, is the manager losing his or her touch?

Breen: For me I try to just take an intellectual exercise and say, what is the thing that's bothering me. Is it bothering me that I owned a fund whose manager bought a stock that went to zero.

Burns: …And bought a lot of it.

Breen: … But the index owned a lot more of it. Every company that went bust in 2008 was in the index, every homebuilder, every bank. So your active manager owned one or two. So, some people that might bother them; me, it doesn't.

What was the process that led them to that? And with Weitz, well, when you dig into the portfolios and talk to them after the fact, it ends up they bought it later than you thought and they got out on the way down. They didn't ride it all the way down. But Weitz was wrong, but his opinion on AIG was, you know, I don't think they are going under. He made a gut call, and if I don't move and start establishing a position now, it's going to bounce back. Totally wrong. He admitted it; got out on the way down. That's always been his process with everything, so I knew that going in.

So, to me it's just you have to set your own comfort level and what you want your manager to behave like. So for me, I don't mind big mistakes as long as they are offset by big winners, and to beat the index by a lot, you have to look nothing like it. So what comes with that territory is, there are going to be periods where you're negative 20 for a three-year period, and the index is positive, but then the flipside is, if you get it right, then you'll be up drastically over time, and all of those funds are.

So, Fairholme, the fund that has done so well for the last decade--over the last decade even after its horrible 2 1/2 years here, it has probably turned [a $10,000 investment] into $37,000; the index has turned it into $20,000. Fairholme is still way ahead. It's deep in the red now, big bet on one sector. That's how the fund has been run since day one, just all the other big sector bets paid off. So, it probably comes with the territory.

Burns: That's something we've been really out talking about quite a bit is, to get real alpha, managers have to take this kind of risk. They have to do this kind of wandering in a lot of ways. It is kind of unfair what's happening to active managers right now, I think, with a lot of the headlines of, you're index-huggers. But that's what people asked for, for a long time. They wanted the index plus a little bit without a lot of volatility. And now everybody is complaining that you're not generating any alpha, which may or may not be true. But to get the true alpha, you have to take a lot of active share, which means you have to take a lot of risk, and you have to do a lot of wandering.

So what we're out talking about right now is, to use active-passive together. You shouldn't turn down alpha, if you think you've got high conviction in a manager. So, if you've got that portfolio of a bunch of wanderers and they all wander into the same corner, you can use ETFs, you can short an ETF out of an exposure, you can keep a core passive, and let the alpha kind of wander, but make sure that they are all communicating to each other.

So, you can use ETFs more as tools and levers to keep that asset allocation plan and that manager conviction plan aligned. And if you really want to be like a lot of institutional investors, you can really do things like "portable alpha," where I've got a high-conviction manager, and I short out the beta, the market beta, and then I can take that alpha that I believe I'm going to have and take it wherever I don't have conviction.

Benz: Well, I guess, there's a risk, though, right. So you're sort of assuming that you're smarter than the active managers who are doing what you hired them to do. Is there a risk that you sort of undermine your own results by neutralizing your portfolio's exposure …

Burns: Well, I think, you have to think about what your plan is. I think your plan should start with an asset allocation. If your plan starts with an asset allocation, you have to stick to that plan. We've actually done some research, just kind of looking at some aggregate flows. It's really striking when you just look at active investors, the $10 trillion active mutual fund investors. What they did in October of '08 and what they did in March of '09 is just abysmally shocking. It shows absolutely, in aggregate, no asset allocation discipline. Sold everything in October of '08, sold equities in '09 and bought fixed income, selling into the bottom.

The funny thing is, when we look at just, say, passive mutual funds, and we look at it by asset class, the flows of $1 trillion market in aggregate were in October of '08, sell fixed income, buy equities, which is exactly what your asset allocation plan should have told you to do. And in March '09, they just kind of secularly purchased everything. So, what we have here, whether you are active or passive, the one message I deliver is that you have to have an asset allocation plan first, and the discipline of rebalancing should be no different whether you have an active portfolio or a passive portfolio. But the fact remains that in '08 and '09, and I'm sure when we get the August flow numbers, which just came in the other day, we're going to see starkly different behavior again.

So to your point on investor returns, if going passive just makes you behave better from a macroeconomic sense, then you're better off going passive, and if you're going to go active and you're going to do foolish things like sell equities in the bottom and buy fixed income at the top, it won't matter what manager you pick; it doesn't matter.

Rekenthaler: It's quite interesting when you put together what Scott's saying and what my research has been doing, which again gets to the point that the common discussion is wrong. The common discussion is people screw up because they go out and they buy bad active funds. That's wrong. They're going out and they're buying above-average active funds and their performance in those funds tends to be as good as the performance of indexes. What's happening is, as Scott says, is that active investors are being undisciplined about their asset allocation decisions and they're piling into categories at the wrong time, and they're getting out at the wrong time, and per his research, passive investors appear to have more of an asset allocation plan and a rebalancing plan. So, the benefit to passive investors is from their asset allocation, it's not from this fund selection thing that people make it out to be.

Now, I will say, his research is showing that passive investors are behaving differently than they were a decade ago, because a decade ago, all the money was piling into the large growth stock index in 1999 when large growth was at the top, and nobody was buying the value index. So if they've improved, and I believe your research that they have, that's a great thing, but that's a change.

Breen: That's a change, and it would be interesting to see how it carries forward with the market, because the long-term data, when I did my study and looked at where the assets had gone versus the successful active funds that we cover and the indexes on the domestic equity side, it was still 70-plus percent of all domestic equity assets were in the S&P 500 index funds or ones with an R-squared of 98 or higher, so like the total stock market index. In fact, the two Vanguard funds, Total Stock Market and Vanguard 500 had 45% of all domestic equity assets in two funds. So, there was this argument where you look and say, a slug of the S&P 400 mid-cap index, which was the best-performing at that time for the last 10 years and still a fantastic record for that stretch, when you go back 10, 15 years there was one fund, one index fund, that had no assets. All of the assets into those S&P 400 index funds came in the last few years. So, the theory is having a slug of that would have been great, but nobody experienced it, because there was no vehicle and nobody was telling them to invest in it. So, I will concede that in the last couple of years definitely it seems to be much better behavior, and I would hope that continues because my fear is the opposite … I saw an article on where the cotton ETN was the number-one performer last week. Do people start thinking they can trade these things, because you have perfect replication and then…

Benz: That's what I want to get into …

Rekenthaler: I would say if you're using … before you get there just to wrap up … I would say one investment approach is to do as Mike is doing--buy great managers, not worry about the asset allocation; you do take on more risk that way, but he is not the only one who has had a great deal of success, and Warren Buffett would tell you the same thing.

The other is, if you're going to use asset allocation and take that top-down asset allocation approach, be disciplined, rebalance…

Burns: Right. It's not buy and hold, it's buy, hold, rebalance.

Rekenthaler: It's buy, hold, rebalance. Get in, which means buying the absolute ugliest stuff at the time when everybody hates it, and that's success and frankly whether you buy active or passive, you are not going out and just buying one of 20,000 funds, as Mike said. If you do a little bit of homework on the active funds, buy a lower-cost active fund with some stewardship and so forth, you will do fine with that approach. People are just having the wrong debate about this. It's about having discipline, and if you're going to take that top-down asset allocation approach, if you apply it with discipline, you are going to do fine, either way.

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