While Vanguard Is Having An ‘Identity Crisis’, I Just Want To Know If I’m ‘Passively’ Or ‘Actively’ Long Jesus

Let me ask you something: if I am long ticker: BLES am I “passively” or “actively” long Jesus?

It’s a good question. To look at the expense ratio, I’d have to say that my faith is being expressed “actively” because after all, the fund’s sponsors are charging 61bps (or six times as much as what I would pay for SPY) ostensibly to ensure that my money is being allocated in a way that pleases Jesus.

That said, if you look at the fund’s holdings, it kinda looks like just a big basket of stocks that, taken as a whole, has no discernible connection to Jesus, unless Jesus was actually an oil baron.

Jokes aside, the question about what it actually means for a fund to be “passive” is about more than costs. If you step back and think about it, “passive” investing is itself a misnomer. You cannot “passively” invest just like you cannot “wakingly” sleep. The term “passive investing” makes no sense.

the term "passive investing" makes no sense. it's like "waking sleeping"

— Heisenberg Report (@heisenbergrpt) September 29, 2017

The idea of “passive investing” is clouded further the more specialized ETFs become. Recall this from Howard Marks (much more here on what happens with trillions of dollars effectively “goes blind”):

The low fees and expenses that make passive investments attractive mean their organizers have to emphasize scale.  To earn higher fees than index funds and achieve profitable scale, ETF sponsors have been turning to “smarter,” not-exactly-passive vehicles.  Thus ETFs have been organized to meet (or create) demand for funds in specialized areas such as various stock categories (value or growth), stock characteristics (low volatility or high quality), types of companies, or geographies.  There are passive ETFs for people who want growth, value, high quality, low volatility and momentum.  Going to the extreme, investors now can choose from funds that invest passively in companies that have gender-diverse senior management, practice “biblically responsible investing,” or focus on medical marijuana, solutions to obesity, serving millennials, and whiskey and spirits.  

But what does “passive” mean when a vehicle’s focus is so narrowly defined?  Each deviation from the broad indices introduces definitional issues and non-passive, discretionary decisions. 

Good points, no? Well as Bloomberg’s Dani Burger (the world’s best Burger) writes on Friday, this is an issue that Vanguard is struggling mightily with. Here’s more:

Are smart-beta funds active or passive? For Vanguard Group, the cost of debating that point has been nearly $800 billion.

At least, that’s how much the rest of the mutual fund industry has amassed in the investment strategies, money management’s hottest innovation since the ETF itself. Only the smallest sliver has gone to Vanguard, thanks to years of soul-searching over how to market the concept without alienating clients trained to resist Wall Street innovations.

[…]

Most of the firm’s reticence has come down to a marketing debate tied to Vanguard’s core identity as an index investor. Executives have been paralyzed by the question of what to call mutual funds and ETFs that group like stocks in categories such as high-momentum or low volatility, known as investment factors.

Are they active or passive?

As Burger notes, if this is parsed relentlessly the semantic debate devolves into “goofiness.”

But one thing that we would encourage investors in “smart” beta ETFs to ask themselves is this: how “smart” are these strategies, really? And further to that point and to the points made above, are you actually a “passive” investor if you’re buying factor-based ETFs? If the answer to that latter question is “probably not,” well then … cue Howard Marks again:

Passive funds that emphasize stocks reflecting specific factors are called “smart-beta funds,” but who can say the people setting their selection rules are any smarter than the active managers who are so disrespected these days?