Each side makes valid points:
Active Management argues…
Passive investing doesn’t allow for the efficient allocation of capital.
There is no attention paid to valuations, fundamentals, etc.
Passive has no chance of outperforming the benchmark
Passive management argues…
Active management has very high fees
Few active managers outperform their benchmarks after fees
Identifying active managers likely to outperform is difficult
In the end, however, it doesn’t matter.
Active or passive: It doesn’t matter.
The argument is largely futile because it misses the point for two reasons.
Relative vs. Absolute Performance
First, the active vs. passive argument is about relative performance, not absolute performance. There will be differences between the relative performance of active and passive managers, but absolute performance reveals the gains and losses experienced. Out of these two measurements, which one would an investor prefer?
By focusing on differences measured in basis points, the investor risks losing the forest for the trees.
Systematic Risk: the 800-pound Gorilla
Second, the active vs. passive argument mainly focuses on fees, asset allocation, and outperforming the benchmark. But what do they offer for mitigating market risk? How does an active management approach or a passive management approach help reduce risk exposure?
The choice between active and passive managers becomes irrelevant because both active and passive managers are heavily exposed to systematic risk. This is the biggest risk an investor faces, yet neither side really addresses it.