Here’s a good interview in Barron’s with James Montier of GMO. But a few things really irked me about the interview. This is unusual for me since Montier is among the very best thinkers on Wall Street. Here’s the snippet that most intrigued me:
Barron’s: Bonds are expensive, stocks are expensive. What’s an asset allocator to do?
Montier: Things just don’t add up. One group has thrown in the towel and says, “If you can’t beat them, join them. I’m just going passive and be damned.” [Passive investing] is a very strange thing to do at this particular point in time.
The U.S. market is at its second or third most expensive point in history. So people are saying, “I either don’t understand the world anymore, or I don’t think that valuation matters anymore,” which is a really weird thing to say. You’re giving up the one piece of information that you know helps determine your long-term returns. You cannot describe yourself as an investor if you are going passive. You are welcome to call yourself a speculator, but you honestly can’t say you care about expected returns if you are going passive at this time.
One of the reasons I am so particular about definitions and details is that so many of the words we use in finance cause unnecessary confusion. You have to have a macro consistent framework for understanding the world of money or else you fall for all sorts of fallacies. So let’s unpack some of this:
- I would argue that James is misusing the words “investing” and “passive” here. James says that someone who is a “passive investor” can’t really call themselves an investor at all. But as I’ve explained before, no one who buys assets on a secondary market for the purpose of savings allocation is actually an investor. They are just savers reallocating their assets. Investors are people who spend for the purpose of generating future production. Most of what’s done in the financial markets is either financing investment or just reallocating savings.
- Similarly, there is really no such thing as passive investing. It’s just a term that was created to differentiate stock pickers from indexers, but in the age of indexing, asset picking (or index picking) has become the new stock picking. We are all active in a technical sense because we all have to choose to deviate from global cap weighting. It is impossible to be a purely passive investor.
These generalities cause many people to conclude that passive investors are basically quitters who don’t care about market valuations and are throwing in the towel by foregoing any sort of thoughtful analysis. But this idea that indexing is average is wrong. The data shows that low fee index funds consistently beat high fee stock pickers.
More importantly, there are tons of ways to skin the indexing cat. Indexing isn’t just some homogeneous endeavor where everyone is doing the same thing. Every single indexer has to choose a strategy. Some choose a simple all stock index to own. Others choose a 60/40 stock/bond allocation. Others choose target date funds. Others choose factor index funds. I, for instance, am a big advocate of countercyclical indexing which is essentially a form of value investing. There are tens of thousands of different index funds to choose from these days and the numbers are only growing. So indexers aren’t just a bunch of quitters who don’t do any analysis or hedging of their portfolios. In fact, it is generally a more thoughtful and intelligent form of asset allocation than more active approaches.
The meaning of these words matter. I am not just being a big pain in everyone’s ass when I get all technical about this. And the reason these words matter is because they lead to all sorts of crazy conclusions when they’re misunderstood.¹ Luckily, I see a lot of people beginning to acknowledge that passive investing is a misnomer. So maybe we’re making some progress here, but until I see widespread acceptance of every idea I ever have I will continue to be a pain in the ass about this stuff.²
- See my full list of investing myths if you’d like to see me be a big pain in the ass about details.
- If there is ever widespread acceptance of my ideas, then please feel free to wake me up from that dream (nightmare?).
NB – I should be clear about the use of “just” in the title here. Indexers quit on stock picking, but in a sense, indexing is just smart stock picking as you’re picking all of the stocks in that index. Of course, an “index” can be anything and is always a human construct so it’s “active” in the sense that it’s created with discretionary parameters. But what you’re doing when you index is you’re diversifying, and as we all know, that’s about the only free lunch in this game.