We read a lot about active vs. passive investing, and mixed into that discussion is index investing. About four months ago I wrote a series of articles on this very subject where I was rebutting an Internet article. On this blog I track 11 portfolios that run the gamut from passive to mosaic to active. To understand each, it helps to go back to Harold Evensky's definitions of what passive, index, and active investing mean.
From Evensky - Passive Management carries many meanings so I leave it to Harold Evensky to straighten us out as to what is meant by Passive Investing. In his excellent book, Wealth Management he provides this crisp definition.
Passive Management is the antithesis of active management. Its core philosophical tenet is that by brains, hard work, and technology, a manager cannot, over time and net of costs, beat the system; he can, however, beat most active managers. Passive management is often assumed to be the equivalent of index management. It is not. Index Management is a special subset of passive management. A passive manager may make active trading decisions. His decisions, however, are based on information currently available to all investors not on an ability to read between the lines or predict future trends and events. Index management is passive management with the added constraint that the manager does not make active trading decisions.
Using Evensky's definition of passive management, the Schrodinger Portfolio definitely falls into the category of a passively managed portfolio. To be sure, "active" decisions were made when the original asset allocation plan was put into action. An active decision was made to emphasize value over growth and smaller cap sizes over larger cap investments. The number of asset classes to include in the portfolio was also an active decision. After making those initial decisions, the portfolio was set to run and subsequent trades only occurred when the portfolio needed rebalancing. In the very early years of operation, the Schrodinger was gifted a few individual stocks. Those were sold and the proceeds invested in non-managed index ETFs.
The Einstein is similar to the Schrodinger in that trades are few. Like the Schrodinger, the Einstein at one time held individual stocks, but this is no longer the case. That could change in the future as the Einstein does not have any restrictions against holding individual stocks. Were individual stocks to be introduced back into the Einstein, I would then classify it as a "mosaic" portfolio as it would be made up of both index and stock investments.
While none of the 11 portfolios are constructed completely of individual stocks, several of the portfolios are actively managed. At least partially in that the ITA Risk Reduction model is a timing or Tactical Asset Allocation model. Using technical indicators such as Exponential Moving Averages (EMA), and Bullish Percent Indicators (BPI), we apply probability arguments to stay on a particular side of the market movement, be it up or down. Portfolios following the ITARR model are: Maxwell, Euclid, Madison, Kenilworth, and Gauss. The "Delta Factor" is another indicator used to determine when it is appropriate to buy or sell an ETF or stock.
Modified versions of the ITA Risk Reduction model are used with the Newton, Curie, Kepler and Bohr. Both the Newton and Curie are mosaic portfolios in the true meaning of the term. Both hold a number of individual stocks and I use some minor market timing with both.
How would I classify an "Index Portfolio?" An example would be a portfolio that is made up of a few index funds or index ETFs such as VTI, VEU, VWO, and AGG. No attempt is made to tilt the portfolio in any significant way other than to include developed international markets ((NYSEARCA:VEU)), emerging markets ((NYSEARCA:VWO)), and bonds ((NYSEARCA:AGG)). If rebalancing were the only reason for trading, this would qualify as a passively managed portfolio.
Are there any truly passively managed portfolios in the stable here at ITA? Yes. Even those portfolios where technical indicators are applied, there are strong elements of passive management as there are asset classes within the portfolios that are held for long periods without any action other than rebalancing.