Visual Proof That Central Banks Killed Active Management

I’ve got a love-hate relationship with low-cost, passive investing.

On the one hand, it’s kind of hard to argue with something that’s low-cost and that simultaneously outperforms alternative strategies that cost more. That’s a no-brainer.

But the problem in the post-crisis world is that investors have forgotten why it is that low-cost vehicles that replicate various benchmarks work so well. These strategies’ outperformance relative to active management is attributable to the fact that central bank largesse has been the rising tide that’s lifted all benchmarked boats.

And that’s fine (I mean, it’s not fine that it creates gross misallocations of capital, etc., but it’s fine from a the perspective of anyone who’s ridden the wave since 2009), right up until passive investors forget to what they owe their outperformance. That’s when the epochal shift to passive becomes dangerous. Suddenly, hordes of retail investors start to believe they stumbled upon some magic formula eight years ago and then they kind of rewrite history to make themselves believe that they did something other than simply ride the central bank liquidity wave.

I’ve gone to great lengths to try and disabuse retail of that notion, and not because I want to make people feel stupid. But rather because I want investors to understand that if central banks pull back and markets are allowed to trade in a two-way manner again, suddenly everyone is going to realize they weren’t the gurus they thought they were.

Well on Monday, Goldman is out with a new piece called “An Rx for Active Management.”  There’s a lot to go through in the note, but I wanted to quickly point out two charts that pretty clearly show why it is that active management suddenly stopped finding alpha.

Via Goldman

The current run of active manager underperformance began shortly after the onset of QE.

QE drove real interest rates lower (measured by the yield on 10yr TIPS). This trend towards 0%, and even negative, real rates coincided with the shift from active outperformance to underperformance (see bottom-left exhibit).




2 thoughts on “Visual Proof That Central Banks Killed Active Management

  1. One problem is that active management is many times favored by financial advisers, because of the money they can make by recommending the funds, as opposed what is best for the client. This happens on low level investors that can least afford the extra fees. The fiduciary rule could fix that, but it has been put on hold. I’ll pay a fee for good advice, but the conflict of interest in these setups is a real problem.

  2. Why not confuse the “regular” dunbsh*t investor ? There is this “hora” around the complexities of $$$ and finance. Confuse the living sh*t out of them and make them feel inadequate and then “cheat’ them out of their hard earned $$$$. Who do you trust??? Surly not most banks, it’s tough on the retail investor especially when the people who should protect them are not.

Speak On It