Skip to Content

Fighting the Right War

Instead of debating active versus passive investing, let’s focus on constructing better portfolios, writes Morningstar’s Don Phillips.

The debate between active and passive management has enriched many academics, advisors, and asset managers who were quick to jump on the indexing bandwagon, but a case can be made that this overhyped discussion has done a disservice to investors on the whole. That doesn’t mean indexing isn’t a fine way to invest. It is. But as indexing marches ever closer to being viewed by advisors and regulators as the only defensible means of discharging a fiduciary obligation, we should be honest about how we evaluate its comparative merit. I see three issues: 1) the mathematical case supporting indexing, while correct at its core, is regularly and often purposely overstated, 2) the theoretical debate between active and passive is largely irrelevant to the choices most investors make, and 3) the active/passive debate distracts attention from the real roadblock investors face, which is assembling better portfolios.

Let’s start with the skewed comparison that fuels the debate: how well the average manager fares relative to the index. This battle pitches the paragon of indexing—a theoretical, no-cost, broad market index—versus an equal-weighted, real-world average of all managers investing in the same space. By definition, the average manager always loses out. But this comparison tells us less about the superiority of indexing than of the inferiority of real-world averages. The average actively managed fund is ugly. So, too, however, is the average index fund.

To view this article, become a Morningstar Basic member.

Register for Free