Let me say right up front that I loved “Moneyball” (both the book by Michael Lewis and the movie starring Brad Pitt). It’s the ultimate “revenge of the nerds” story — academic quants who never made any teams in their lives, along with one smart former player, use data mining to turn conventional baseball wisdom on its head and change the Major Leagues forever. For those of us who leaned toward the thinking side of sports, it doesn’t get any better than that.
So when I saw the headline of Ginger Szala’s April 28 ThinkAdvisor story, “Michael Lewis: A Warning for Index Investors From the Oakland A’s,” I was hooked. Her article is about Lewis’s remarks to advisors attending the Morningstar conference in Chicago, particularly his concerns about the current trend toward passive investing. However, he didn’t seem to provide much useful advice on how financial advisors might respond the problem.
“The move of active management inflows to passive management is one of the great changes that has swept the investor world since I stepped foot in the business,” Lewis said. “In the extreme, no one is making judgments. There is constant friction between [statistics and judgment]. People have to acknowledge the power of data, even worship it, but not at the expense of total stupidity.”
It’s hard to argue with Lewis’ observation of the move to passive management (recently accelerated by the Department of Labor’s focus on investment costs), or his conclusion that indexing has greatly reduced judgements about individual stocks. But how important are these trends to financial advisors, their clients, and the advice they provide?
In the investment world, Lewis’ “total stupidity” usually refers to risk: particularly the relationship between risk and reward. Taking a small risk for a potentially large gain is widely considered to be smart. Conversely, taking a large risk for a potentially small gain would generally fall into the “total stupidity” category. So, how are we to apply these concepts to passive versus active investing?