Imagine you sent 100 bombers on a mission. Fifty crashed, and 50 dropped their payloads and returned. What if you looked at the 50 that returned, called the mission successful and then wrote a report that never mentioned the 50 lost planes?
That’s essentially what many mutual funds and investment data providers do when they report the performance of actively managed mutual funds and ETFs, according to Charles Ellis, the founder of consulting firm Greenwich Associates, who has also long been known as the dean of American investment advisors.
Money has been shifting dramatically from active to passive management for the past two decades, but more money is still managed actively. Actively funds of all kinds, including money market funds, manage about $15.4 trillion and passively managed funds and ETFs manage $6.7 trillion, according to Thomson Reuters’ Lipper.
Ellis was a proponent of active management—which means hiring a manger to pick stocks in an effort to beat the market — early in his career. But he has since flipped the script, steadily becoming a critic of active management over the years. His recent book, Index Revolution, is a case in point.
“You’ve got millions of people using (active management) for their retirement savings,” Ellis said. “But people aren’t making money. It’s all about sales for the fund companies.”
Active management is falling short, he says, because of the way the market has changed. Decades ago, most trading was done by amateurs, making it easy for skilled professionals who had access to proprietary data to beat the market. Now, 99 percent of trading is done by experts and computers who are so good that they can’t beat each other. “The willing losers have been outnumbered,” Ellis said.