Morningstar Advisor - February/March 2011 - (Page 7)

Letter From the Editor Ducking for Cover Morningstar’s Michael Breen was on a duck-hunting trip last fall when he ran into a hornet’s nest. And it wasn’t in a field in the middle of North Dakota, but online at Morningstar.com. Before leaving town, the associate director of fund analysis posted on article on the website titled, “Give Peace a Chance in the Active vs. Passive Debate.” No such luck. Breen wasn’t trying to be ironic. It was a sincere effort to put the active-passive discussion into context, asking readers to step back and consider that both types of investing have their merits. “I’ve learned that the truth is often in the middle of such contentious issues,” he wrote, “and the only way to find it is to run your own data to see what questions percolate up from there.” He crunched some numbers and concluded that investors “willing to roll up their sleeves and do a little fundamental research” have a good chance of picking active funds that outperform the market and that index funds deliver solid returns “in a cheap, low-maintenance package that’s a perfect fit for many investors.” Sounds reasonable and uncontroversial. Well, first came the pro-active crowd, crowing in the comments section that Breen’s study proved their point. The indexers counterattacked by poking holes in Breen’s research. And the argument was on. Breen was getting hammered so bad that he felt compelled to head to a Starbucks in Bismarck to respond to the commenters. Luckily for him, he was holed up in a duck blind the rest of the week without Internet access. Although lively debates about investing can be terrific learning experiences for all involved, the active-versus-passive discussion has hit a wall; it’s no longer productive. It’s time to move on and talk about the good attributes of each while acknowledging the shortfalls. Instead of denigrating one side, we should be exploring ways to use both to get better investment results. This is our goal for this issue. There are many more things to consider than merely choosing between being active or passive. Take costs, for example. In “It’s More About Costs Than Being Active or Passive” (Page 40), Morningstar director of fund research Russel Kinnel makes the case that investors should focus more on the expense ratios of funds than whether the funds are active or passive. He also says that the lowest-cost option is not always an index fund. Jon Hale, a consultant for Morningstar Associates, discusses in “Play Your Stars” (Page 44) how his group creates diversified portfolios with pinpoint allocations using a combination of the best go-anywhere managers and funds that specialize in one area of the market. In the article “In Between Active and Passive” (Page 46), ETF analyst Michael Rawson explores a relatively new breed of ETF that falls in the middle of active and passive: enhanced indexing, which uses quantitative methods to create portfolios that have both active and passive characteristics. Another ETF analyst, Samuel Lee, shows how investors can uncover supposed active managers who are actually closet indexers in “Selling Beta as Alpha” (Page 49). Using a ground-breaking measure called active share, he then demonstrates how using a combination of index funds and highly active managers can achieve better results at a cheaper price than settling for index-huggers. In his article, Breen hit the nail on the head: “Maybe it’s time for the rest of us to start thinking of it as active and passive, not active or passive.” After reading this issue, I hope you agree. Jerry Kerns MorningstarAdvisor.com 7 http://www.Morningstar.com http://www.MorningstarAdvisor.com

Table of Contents for the Digital Edition of Morningstar Advisor - February/March 2011

Morningstar Advisor - February/March 2011
Contents
Contributors
Letter From the Editor
First, Do No Harm
Do You Use Active or Passive Investment Strategies?
Best of Both Worlds
How to Build an Index
Accountable Investor
Nice Guys Finish First
Four Picks for the Present
Investment Briefs
A New Guardrail Against Risk
Tech Loosens the Purse Strings (a Bit)
It’s More About Costs Than Active or Passive
Play Your Stars
In Between Active and Passive
Selling Beta as Alpha
The Weighting Game, and Other Puzzles of Indexing
Leaving the Nest
Redefining Credit Risk
Another Vote for Market-Based Credit-Risk Measures
Big Opportunities in Small-Cap Stocks
Benchmarks? What Benchmarks?
Mutual Fund Analyst Picks
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
VA Sales Slide, but Assets on the Rise
Indexing’s Lunatic Fringe

Morningstar Advisor - February/March 2011