Under the Hood: Diversification and the Active Manager, Part II
Indexation is unique inasmuch as there is no forecasted return associated with indexation. If the S&P 500 were to decline by 50%, this does not invalidate indexation. There is no consequence for the index, it’s merely the return that the index produced — it can’t underperform itself. Active managers, however, are evaluated relative to the index, though it is effectively impossible for active managers in aggregate to outperform the benchmark. What is necessary, then, is a departure from the investment behavior generally exhibited by active managers. They must be willing to eschew diversification to allow high conviction investments to grow as a share of their portfolio. In essence, they must behave in ways that the index cannot. Included herein are two of the best-known stocks in the world that anyone could have bought and held for a one or two decades and become the top performing manager of their era. Not only didn’t any active manager do that, neither did any index, but nor could any index have done so.
Read More >