Why Swensen, Buffett Preach Passive—But Bank on Active

In the words of Morningstar’s VP of research, “What gives?”

Some of the biggest proponents of passive investing don’t practice what they preach on the active versus passive debate, according to Morningstar’s Vice President of Research John Rekenthaler.

In his latest column, Rekenthaler argued that while financial experts including Richard Thaler, Eugene Fama, Warren Buffett, and David Swensen advise other investors to stick to index funds, they themselves are active managers.

“The very people who have been most associated with the boom in indexing run actively managed portfolios. What gives?”Thaler is a principal at active management firm Fuller & Thaler Asset Management, Buffet picks stocks for Berkshire Hathaway’s portfolio, and Swensen actively manages Yale’s endowment fund.

Even Fama, who Rekenthaler acknowledges is “not fully an active manager,” is “more of one than you would think, given that he’s the person dubbed by Wikipedia as the ‘father of the efficient-markets hypothesis.’”

Other indexing advocates who the columnist called out as active managers included Harvard professor Andre Perold, Yale’s Roger Ibbotson, Nobel laureate Myron Scholes, University of Illinois professor Josef Lakonishok, and MIT’s Andrew Lo.

“Academic literature, MBA classes, and the media encourage investors to index,” Rekenthaler said. “Meanwhile, many of the most informed, influential researchers, the very people who have been most associated with the boom in indexing, run actively managed portfolios. What gives?”

The Morningstar researcher attributed this difference between action and advice to the “twin temptations of ego and lucre.”

“Although none of these experts will admit it, they each believe that they are smarter than the rest of the market’s schmoes,” Rekenthaler wrote. “Their confidence is understandable. They are very bright. They have had tremendous professional success. And, for many of them, their belief in their own abilities has been vindicated by the investment results.”

The other reason why these experts don’t invest as they advise is because even “avid advocates of market efficiency, and thus of indexing, lack complete faith,” Rekenthaler said.

“Yes, the financial markets are typically ruthlessly efficient at absorbing investors’ aggregate knowledge and incorporating those insights into stock prices, but they have all seen strange things occur… often enough to give pause to any notions of full market efficiency,” he wrote.

For example, Rekenthaler pointed to the continuing success of the momentum factor, which Fama has called the “biggest embarrassment for efficient markets.”

“It makes sense for financial experts to recommend indexing to outsiders, and it makes sense—psychologically, financially, and intellectually—for them to behave otherwise,” he concluded.

Related: Indexing’s Brave New World & Profs vs Quants: Who’s the Better Investor?