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Financial advisers need to stop bragging about 'active management'

Who has two thumbs and probably shouldn’t suggest active investment management outperforms passive benchmark tracking? This stock-art-picture guy.

Lisa F. Young/Photos.com

A financial adviser was recently quoted in the press as saying active managers seek to shelter investors during downturns and outperform during good times, and that this is one of many reasons why active management is better than passive investment management. I won't single out the adviser, because he's not alone in holding up that flag.

The article in which this analysis appeared rightly indicated that active management has collectively been shown to underperform passive alternatives. One logical conclusion must therefore be that to reconcile these two positions, active managers must predominantly underperform in sideways markets.

Or, if they are merely suggesting that it's possible to outperform in both up and down markets, what good is that possibility if it's not a high probability? No one has found a way of identifying rare, long-term active outperformance in advance, so overall it's a useless argument. And certainly not backed up by data in any way, shape, or form. Actually, the data support the just the opposite.

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I feel bad for the few managers out there worth looking at: They have to bite their lips when sales agents (financial advisers) try to defend them with flawed arguments. When you have few friends left, it's hard to tell them to help you by stop trying to help you.

By virtue of the structure of the financial advice model in Canada, generally you're going to be stuck with actively managed portfolios whether you like it or not. While the seeds of change have been sowed, it will be a while before financial advisers provide passive portfolio options to investors on a level playing field with active products. There are other benefits an adviser can bring to the table, and for the time being the industry should focus on those.

We should be talking about the behavioural and ancillary planning benefits a good adviser can bring to the table. Investors can cripple their returns by reacting with fear and greed no matter what kind of products they use. A good adviser can get you to save more money, keep you from selling when markets are falling and rein you in from getting carried away when markets are hot. They can make sure you have an estate plan, the proper insurance and keep you on track, and those things can far outweigh the performance drag of actively managed funds versus their benchmark-tracking passive brethren.

I'm a firm supporter of getting beyond the passive versus active debate for the majority of investors for now, because it's still muddied by an uneven playing field.

But if the friends of the financial adviser industry really want to help, maybe they can work on a sales pitch the data actually supports.

READERS: If passive investment management shows better performance, do you think financial advisers can still provide value to clients? Let us know in the comments.

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About the Author
Personal Finance columnist

Preet Banerjee is a consultant to the financial services industry. You can follow him on twitter at  @PreetBanerjee. You can find his conflict of interest disclosure on his website. More

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