The Delusion of Passive Investing

The word delusion carries with it several meanings, all of which are not very complimentary. According to the online version of the Oxford Dictionary and we quote:

delusion de•lu•sion
– noun “a false belief or judgement about external reality, held despite incontrovertible evidence to the contrary
Synonyms – misleading, deluding and deception.

To accuse our industry of being delusional must come with sound evidence and reason.

In our short thesis, we want to make the case that there is no such “thing” as passive investing and that investors need clarity through a profound understanding of knowing what they own in their portfolios and why they own it in the first place.

Traditionally, passive investing meant that investors came to the realization that no one could outperform the “market,” so they just purchased an index-based product and were satisfied to let it ride.

Active investing suggested that a cogent strategy of selection could produce similar, if not better results, if one was simply committed to it.

The problem with so-called passive investing is that there is not one single index that simply covers the 6,000 publicly traded companies that is non-market cap weighted. If that were not the case, investors could simply hold all the stocks in the universe in one basket and ride the wave to where it takes them. However, this basket of stocks does not exist in the form of one fund, so investors have had to reduce themselves to owning a “version” of the universe.

The often-quoted Dow Jones Industrial Average is a subjectively developed price-weighted index of 30 US Large Cap companies designed to replicate the universe of 6,000. The S&P 500, on the other hand, is a subjectively developed market-cap weighted index of 500 mostly US Large Cap companies, which, based on research gathered at, states that this represents 18% of the world’s financial assets. If this is the case, why then do we refer to it as the so-called “Market” when it leaves behind 82% of the rest of the pie?

Please note, in our description of the Dow and S&P 500, we used the word subjective in describing the construction of the index. This means that actual human beings sit on a committee using proprietary criteria in deciding the composition of their index as they best see it. If that isn’t active management, then we don’t know what is. That fact is, in our opinion, we have been duped into believing that because the word “Index” is slapped on a collective fund, that it means no human involvement was taken into consideration – when nothing is further from the truth.

So, if all investing requires a human element, how does an investor choose what is proper for them? This is a great question! At Nepsis®, we believe a process that provides unfettered clarity should be the deciding factor. Clarity can be broken down into the 4 Keys to Successful Investing — Philosophy Strategy Flexibility Transparency®.

So, ask yourself the following four-questions:

  1. Do you understand the underlying Investment Philosophy, and can you describe it?
  2. Does the Investment Strategy you employ align with your goals and objectives?
  3. Do you know how much Flexibility the investment committee or managers have in implementing that strategy?
  4. Is there Transparency in how changes are made, including taking taxes under consideration?

Can you answer these the four-questions as it pertains to your funds?

If you answered “No” to any of these questions, you may be under the delusion of passive investing. More importantly, you may lack clarity in your investing.

Our hope is that we have somewhat exposed the false narrative of active vs. passive investing and have explained that all investing is a form of active management.

In closing, our belief at Nepsis®, is that the era of so-called passive investing will soon be abandoned when it is fully exposed for what it is – active management.

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