It took a while for “Moneyball,” the data-driven approach to baseball described in Michael Lewis’ thusly-titled book and the subsequent movie, to establish its place in a sport traditionally driven by folklore and stereotypes. Fans know its working pretty well given the way modestly financed teams now compete with and beat wealthier old-school franchises. And now, Moneyball’s Wall Street cousins are elbowing their way into the middle of the old passive-active club.

The Passive-Active Dichotomy Is Ringing Hollow

When listening to so-called passive and active debaters mix it up, do you get the sense that both seem to be missing something important? The passive crowd has become befuddled to the point that it’s not sure how to react to the phenomenon of humans using brains to make decisions. Meanwhile, active investors wonder if doing anything more disciplined than casting spells and reading tea leaves means they’ve been taken in by the undead, or, rather, the uninvestors (the passive crowd).

What’s a contemporary strategist to do?

The Lay of the Land – Really

I think the only way to understand who is doing what is to ditch the now-stale active-passive dichotomy and recognize a new threesome that includes Moneyball-type newcomers. Here’s a proposed new set of classifications.

Top Down (or Index Based)

I refer here to investors who choose stocks based on their inclusion in some sort of broad and possibly generic category. Major index funds are an example. So, too, are sector funds or country/region funds.Broad-based size-related categories would qualify. Another example would be with general style-specific funds, such as ETFs that track Value or Growth indexes.

The idea, here, is that the investor is not deeply concerned with individual company-stock characteristics and what works or doesn’t work. That is not passivity: This investor determines (subconsciously if not openly) that certain broad categories of stocks have significant common elements that outweigh security-specific variations. In other words, small-caps have certain return-risk qualities, by virtue of size, that warrant (or do not warrant) having exposure to the group – and that this is so regardless of which small-caps companies cut guidance, announce stocks buybacks, outgrow peers, etc. We wouldn’t care what particular stocks are in the group; we just want them to be small caps, and that the group be defined in a credible way (in other words, a small-cap group consisting of issues with market caps above $100 billion would not cut it.) Other examples would be Healthcare-sector equity ETFs, Developed Europe ETFs, etc.

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