Will Passive Investing Become an “Expensive Mistake?”

A recent article in Advisors Perspectives shares an interview with fund managers Matthew McLennan and Kimball Brooker, Jr. of First Eagle’s Global fund, which holds over $55 billion in assets.

Here are some highlights:

  • Regarding their investment philosophy, the managers say that they focus on two key criteria when evaluating purchase opportunities—price, and the durability of the company they’re looking at.
  • The managers don’t have a strategic allocation to cash, but rather allow cash balances to ebb and flow with opportunities in the market.
  • On renewed market volatility, McKlennan says, “The volatility that we have seen in the first part of this year is a return to more normal levels. It just feels elevated by virtue of the extremely low levels of volatility that we saw in 2017.” He notes cyclical factors, a tighter labor market and monetary forces as contributing elements.
  • McKlennan comments on China’s potential as a destabilizing geopolitical force­­­­­­: Although the Chinese government, he says, has brought large numbers of people from poverty to reasonable income levels, the country’s growth has been fueled largely by debt. Characterizing this as a “red flag,” McKlennan argues that such a combination has preceded most of history’s financial crises.
  • Kimball says the team has found interesting businesses in the U.S. in the health care services space and has also “identified a collection of businesses that are more idiosyncratic opportunities, which are mainly abroad.”
  • On quant versus active-investing strategies, McKlennan argues that a, “a quantitative strategy with a factor tilt has the ostensible allure of a disciplined approach that is cheaper to implement than active management. But one of the things we would caution investors against is the belief that there is a panacea in any one quantitative variable.” He also notes that a quant, factor-based approach may not take into account is “agency risk of poor management decision making.”
  • McKlennan notes the potential for passive investing to become an “expensive mistake” in the years to come due in part to our leveraged global economy (which will challenge nominal economic growth), and a “complex multi-polar geopolitical world.” He concludes, “This is exactly the kind of environment where an active approach focused on risk mitigation has the potential to make a great deal of sense even though the rear-vision mirror has been extremely rewarding to passive investing.”