If you’re familiar with my back story, you’ll know that I committed the cardinal sin of abdicating responsibility to my ‘professional’ wealth manager. He went on to lose me £151,600 in 18 months at Dotcom 1.0 crashed and burned.

In his new book, The Sceptical Investor, Money Week editor John Stepek (above) warns against a similar malaise that he sees developing in today’s hot investment trend – passive investing.

The principle is sound enough – most managers of active funds fail to beat the market at all, let alone consistently over time. So why pay their inflated fees for under performance? Better to follow the market as a whole with a low cost ETF tracker.

Well, yes and no. Like many good ideas, this has worked well for the early adopters. There was a time when you had to pay active level fees for what were effectively tracker funds. The development of Exchange Traded Funds driven by algorithms rather than humans has brought costs down to a fraction of a per cent. However, that business model only works if the ETF can attract funds on a big enough scale to make a 0.3% charge amount to a hill of beans.

Because they need scale, these ETFs can only own the shares that are big enough to absorb their money without moving the market. This leads to a concentration of ownership of a relatively small number of shares which become ‘over owned’. The constant inflow of cash means that some under performing companies are propped up by automated purchases at prices that move further and further away from anything to do with business fundamentals.

Passive investing almost encourages a ‘set it and forget it’ mentality among investors. This is encouraged by some commentators such as Tony Robbins who implies that you just have to roll with the punches across the decades to ensure a positive outcome in the end. That approach would not have helped you in America from the mid 1960s to the mid 1980s, or in Japan from the early 1990s to the present day.       

There was a time when residential Buy to Let was a great investment. It started in the early 1990s and shrewd investors did some great deals after the 2008/9 crisis. But when the government woke up in 2014 and realised there were 2 million private landlords with assets waiting to be stripped, a five year vendetta began which has all but killed the sector.

Stepek believes the same thing could happen with passive investing. Quite simply, when everyone piles into the same trade it can only under perform. You an only get average results when you do what everyone else is doing. If you’re familiar with our Wealth Pyramid concept, you’ll know that we have a layer in the pyramid dedicated to ‘meta diversification’. This moves beyond conventional asset classes to include things like multiple countries of residence, cross border businesses and ownership of assets in multiple geographies and political regimes.

Stepek talks about the Meta Game, where you look beyond the 3.3 million indices available to invest in and consider the human psychology of the process. It’s the reason why Warren Buffet prefers to take his companies private so the management can focus on the long term interests of the owner rather than the short term demands of Wall Street. By all means have some of your funds in well diversified passive funds – we would see these as part of your ‘bedrock portfolio’. But you also need to take some contrarian stances if you expect to out perform the masses.

This could be owning public companies that are under-invested because they are not big enough for the ETFs to auto-purchase. It could mean owning private pre-IPO companies in the hope that you’ve found the next unicorn. Or it could be early adoption of ETFs in frontier markets like Vietnam or emerging asset classes like cryptos and cannabis. This is never going to be the easy option, but then few people get rich doing exactly the same as the crowd.

The exciting news is that, if you want to learn more about these strategies, John Stepek has agreed to be the keynote speaker at our next event at a brand new venue in Baker Street on Thursday 26th September. Even better news is that the first 50 people to sign up will receive a copy of John’s book, The Sceptical Investor. Click here if you intend to be one of them.

Until next time

Graham