The stock market is a self-regulating
god, perfect in its random, short-term unpredictability. It will do
what it will do, reacting to events nobody can predict and trends you
are powerless to influence.
There are two kinds
of investment approaches - active and passive. Active investors try to
beat the Street. They get all the attention, the press and the glory
when they're right. They are people like Peter Lynch of Fidelity, Mark
Mobius of Templeton and Ian Ainsworth of Altamira - mutual fund
managers who have achieved star status because they actively sought out
companies that gave their funds returns vastly exceeding the market
This star factor has permeated our
investment culture. All the newspapers and financial magazines rate
mutual funds every month or every quarter, ranking them by their
Active investors are
divided into two groups, those who seek growth and those who seek
value. Growth investors try to spot companies on the move, with the
potential for quick capital gains as other investors realize the
potential, and pile on. Their targets are companies with rapid growth
rates, even if profits are lagging behind, or nonexistent. More
important for them is the potential for earnings, in the belief that
the stock value will rise even more as that potential is realized.
Classic examples of these were the Internet and dot-com stocks that
investors couldn't get enough of on the late 1990s - often companies
with just an idea, no track record, no expectation of profit, and who
lived off the money the market threw at them.
while that tech bubble ended in collapse, growth investors who bought
in at an early stage, and sold at the zenith, made huge amounts of
Value investors want nothing to do with
hype, future success or rapid capital gains. Instead they actively seek
out companies which are undervalued and selling at market values below
the actual value of the assets they own.
formulas used to determine this include price-to-earnings ratios and
price-to-sales ratios, along with corporate balance sheet. Value
investors are willing to wait for their returns, and choose a path of
less risk to get there. For the first half of the 1990s, as markets
were choppy and uncertain, value funds like Trimark were hugely in
favour. During the second half of that decade, when tech stocks were
the rage, so were growth funds like Altamira's Science and Technology.
trouble with most active investing, either for growth or value, is that
it doesn't work. By that I mean, eight times out of ten, actively
managed mutual funds fail to beat the Street.
general, indexing is a winning strategy, so long as you don't try to
time the market. It is better to give up any hope of outperforming the
market in the security that you will never under perform it. That
realization, combined with the incredible volatility of markets over
the last few years, has led to a massive increase in the size and
number of index funds. In Canada now, all the major banks offer a
squadron of index funds, with CIBC remaining the leader.
why does passive investing almost always beat active investing? After
all, it shouldn't be that way. Smart people who can track things like
economic trends, demographics, the course of interest rates and
technological advance should be able to pick sectors and market-leading
companies whose growth will be greater than that of the general
economy, as measured by the Dow or the TSE. That, after all, is what
you pay management fees to mutual fund managers to figure out.
reason is simple. It's human nature. Active investors, even the
professional fund managers, are by definition trying to get ahead by
making temporary decisions. That opens the door for ego and emotion to
cloud the decision-making process; for a hot tip to replace research;
and for strategic inconsistency as investors try to react to every
interest rate adjustment, trade figure or tax change. The victim here
is perspective and the long view of where we may be on the long wave.
active investing seizes the attention of the media, then everybody
wants to own the same companies - the ones with the star stock
performances that have usually led them to be worth much more than the
assets behind them, and have shot skyward in terms of price-to-earnings
ratios. Remember: many active investors lined up to buy Nortel at $100
and lined up to sell at $12. These active investors in this and other
hot technology companies lost more than 80% of their money, while
passive investors who may have bought an index fund on the day it was
at its absolute peak, were down little more than 30% at its absolute
Of course, if you can strip human fear,
greed and hope out of active investing, then expect to win. If you
can't, don't even try. But there is no excuse for everyone not having a
profound exposure to the market, judiciously purchased and long held.