by Cullen Roche, Pragmatic Capitalism
Big news, nerds – Burton Malkiel has changed his mind. The investment legend, who has spent his entire life chastising alpha chasing active management, has moved over to the dark side. Malkiel, the Chief Investment Officer at Wealthfront has rolled out a new strategy that they’re calling “Passive Plus” indexing. The strategy is another name for Smart Beta which is another name for active deviations from market cap weighting. This is a big change in views considering he said this just a few years ago (link was deleted by WealthFront for obvious reasons):
“‘Smart Beta’ portfolios are more a testament to smart marketing rather than smart investing.”
- The Efficient Market Hypothesis is a useless theory that basically says “prices move and markets are hard to beat after taxes and fees”.
- Our entire industry misuses the terms “active” and “passive” in ways that mostly just cloak the way high fees are charged in certain products.
- These confusions are directly connected and are due to inconsistent underlying theories about the way the financial markets work. More importantly, the terms are consistently misused to sell high fee products and especially products that are higher fee than market cap weighted products.
So, what’s happening with Malkiel? Why is he suddenly embracing the alpha chase via Smart Beta? In my view he’s changed his mind because he never really had a cohesive and consistent underlying theory in the first place. Malkiel was always an advocate of active investing whether he understood it or not. This was evident long ago when he wrote articles about picking the best dividend paying stocks (which turned out to be the worst) or when he said no one should hold one of the largest asset classes in the world (he was making a purely political argument that was anything but random walking). Malkiel never walked the random walk.
This is important because it means that some of the foundational theories that investors rely on are incorrect. It means that the academic work that these theories are built on is also wrong. But what’s happening now is more troubling in my opinion. What he’s done is pivoted from one form of active management to another worse form (market cap weighted to factor picking). Smart Beta and Factor Investing are nice sounding theories backed by lots of academic research. But they are also largely untested in the real-world and generally involve higher taxes and fees. They are, to be blunt, strategies that sell the hope of alpha in exchange for the guarantee of higher fees.²