Lesson 3: Investment Style

JARGON ALERT! This is probably the most debated topic in the investment community. I’ve tried to make it as clear as I can, which is difficult for a tech geek like me to do, so bear with me on this one. Its easy to get confused by all of the different strategies out there. It really all boils down to whether your money manager is active or passive.

Key Concepts:
1. Active vs. Passive Money Management.

Passive management refers to a buy-and-hold approach. Its mantra is derived from the ‘efficient market hypothesis’, which states that market prices reflect all the knowledge and expectations of investors. Any new development is instantaneously priced into the security, thus making it impossible to consistently beat the market. The passive strategy is generally focused only on the entry or diversification, ignoring market conditions. Lacking a predetermined sell strategy, they chose to accept market and selection risk. The problem with this style is its complete failure to deal with systemic risk (risk that cannot be diversified away) like we saw again in 2008.

Active Management can agree in principle with part of the ‘efficient market hypothesis’ but takes it a step further by asking, “If price reflects all the knowledge and expectations of investors, why do you chose to ignore it?” A more sound and complete strategy listens to what the markets are saying, via prices, and reacts accordingly. Active managers have both buy and sell disciplines to create a purposeful shifting of capital between asset classes in response to changing market conditions. Instead of accepting risk, the Active Manager’s primary objective is to mitigate losses in significantly declining markets by avoiding under performing asset classes. In rising markets we concentrate on those asset classes exhibiting the greatest momentum.

In the simplest terms we seek to sell things that are going down and buy things that are going up. This should not be confused with market timing. The age old saying of ‘buy low, sell high” is market timing. We don’t pretend to know how to pick an exact market low (or high), we just dynamically react to current market conditions.