One of my favorite blogs, The Monevator blog, did a brief write-up on my new paper this weekend.  If you don’t read their website you’re missing out because they consistently post some of the best financial content around. Anyhow, they had a very fair and objective view of the paper and approach to portfolio construction.  However, one point that I seem to lose a lot of people on is my discussion of active and passive investing. So, I wanted to take this space to clarify a bit.

Financial commentary doesn’t have a uniform definition for passive investing. Googling the term brings up the several different results:

Passive management (also called passive investing) is an investing strategy that tracks a market-weighted index or portfolio. – Wikipedia

Passive investing is an investment strategy involving limited ongoing buying and selling actions. – Investopedia

The first definition is vague because there are limitless numbers of market cap weighted indexes these days, some of which are not well diversified and not low fee. Additionally, why should passive indexing be limited to market cap weighted index?  Is it really correct to say, for instance, a fund like MORT, with 23 REIT holdings, reflects passive investing better than say, the equal weight S&P 500 ETF?  An “index” is a rather arbitrary construct in a world where there are now tens of thousands of different indexes.

The second definition is equally vague since an investor can hold a handful of stocks in a buy and hold strategy and limit ongoing buying and selling. Clearly, we shouldn’t call that passive investing in the sense that a low fee indexer would advocate. The new technologies such as ETFs have really muddled the discussion here as there’s now an index of anything and everything. So, as Andrew Lo notes:

“Benchmark algorithms for high-performance computing blurred the line between passive and active.”¹