The case for active management

Let’s get one thing out the way. There is no strong case for active management. It is costly and underperforms its passive counterpart on average. But can some forms of active management be beneficial? I think so. Active management must be low-cost and long-term to add any value. It is for this reason that you won’t find many unit trusts/mutual funds that tick these boxes. Asset managers are in it to make money, not to grow investors’ wealth (although many will try to convince you otherwise).

A good way to illustrate this is to tell you about John Bogle. John Bogle is the founder and former CEO of the Vanguard Group. Vanguard is famous for indexing. Mr. Bogle is arguably the world’s foremost proponent on the merits of passive investing. It is because of this that I was intrigued to see to see his views on the Wellington Fund (One of Vanguard’s active funds). In his book, The Clash of the Cultures, Mr. Bogle highlighted the following:

“It’s a real world chronicle that describes the impact on individual investors in the Fund as it moved from one culture to the other, and then came home again. Wellington’s rise from 1928 to 1966 succeeded because it focused on long-term investment. When the Fund turned its focus to speculation in 1966, it was soon hit by the 1973–1974 market crash and experienced dramatic declines in returns. Its renaissance began in 1978 when it went “back to the future”, and returned to its original focus on investment, establishing firm guidelines on the balance between dividend-paying stocks and investment-grade bonds.”

When the Fund turned to speculation it became short-term focused and doubled its annual portfolio turnover (which increases costs). An excerpt from the Fund’s 1967 Annual Report is as follows:

“Obviously times change. We decided we too should change to the bring the portfolio more in line with modern concepts and opportunities”

If your investment manager ever says something like the above then run for the hills. “Modern concepts” is code for chasing the latest investment fads while finding “opportunities” means trading in and out of positions in investments. These are both things you would hope an investment manager would avoid.
 
 Mr. Bogle goes on to name the key ingredients of success as:

“Long-term focus, clarity of strategy, wide diversification, rigid rules for portfolio selection, and yes, minimal costs.”

So if you are going to follow an active approach, you had better consider Bogle’s ingredients. A dividend growth strategy is one that has these ingredients.

October 2016 Update:

Let me be clear, I am not saying that dividend investing is necessarily better than passive investing. I am saying that dividend investing can also achieve an investor’s long-term goals. I prefer dividend investing as I like the idea of building a sustainable income stream. I spend a couple of hours a week on my investment portfolio and evaluate how I am progressing towards my goal of building a retirement income stream.

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