Why settle for average from your investments?


The S&P 500 is up nearly 30% this year to outperform almost every other major asset class, so it’s not surprising that investors are pouring billions of dollars into index funds and ETFs designed mirror the market.

However, are investors potentially shortchanging themselves down the road by settling for “mediocrity?”

There’s an illuminating addition to the active vs. passive investor debate courtesy of the New York Times, which has an interesting profile of mutual fund manager Robert A. Olstein. He manages the Olstein All Cap Value fund and challenges the notion held by some that index funds, which simply track the market rather than trying to beat it, are the best way invest.

The odds of outperforming the overall market return are slim, and that, as the Times points out, is backed up by “decades of academic research, including the work of Eugene F. Fama, one of the finance professors receiving the Nobel in economic science this weekend.”

Not necessarily so, says Olstein, whose flagship fund since its inception in 1995 has returned 10.7% annualized–or more than 2.4 percentage points better than the S&P 500 (SPX) over the same period. He thinks the soaring popularity of indexing is part of a trend toward sloppy investing — a willingness to follow the herd, to rely on momentum in a rising market. Says Olstein:

It’s like saying mediocrity is O.K. — that it’s more than O.K., it’s the best that anyone should hope for. It’s saying a guy like me can’t beat the market — that he shouldn’t even bother trying. That’s wrong! It really ticks me off.

At Covestor, we have nothing against passively managed index funds and ETFs, and think they are great, low-cost vehicles for the “core” of a portfolio. Yet we are also convinced that adding up-and-coming, active managers to the mix can help investors generate “alpha” (excess risk-adjusted returns). The key is finding the right manager–and that’s what Covestor’s investment philosophy is all about.

Or as Covestor Chief Investment Officer Sanjoy Ghosh explains:

On-going research is essential for generating alpha – well documented financial anomalies often get arbitraged away as investors exploit mispricing that may exist in certain market securities.  Outperforming the market is not easy – it requires discipline, hard-work and investment acumen, but it is not an impossible task. As such, it is advisable to allocate a certain amount ones risk budget to alpha strategies and invest in active managers who invest heavily in research and have a disciplined investment process.

Meanwhile, Financial Times columnist John Authers says active managers think it is time for the Revenge of the Stock Pickers. Active investors have had a tough time outperforming major benchmark indices since the 2008 financial crisis given an unusually high correlation among various asset classes. It was tough to find the winning trade.

As global investors become less fear-driven and with correlation levels easing that’s starting to change, writes Authers, though active managers will need to deliver.

Reduced correlation merely gives stockpickers an opportunity to show their worth. It does not guarantee it, and it also allows them to underperform by more. But unless markets lapse into a new crisis in the new year, the logic is that there is money to be made by those who spot mispricings. Active managers’ challenge is to find them.

Read more about Covestor’s investment philosophy.

Photo Credit: underwaterguy

DISCLAIMER:  The information in this material is not intended to be personalized financial advice and should not be solely relied on for making financial decisions.  Past performance is no guarantee of future results.