Investors continue to debate management superior to passive management or vice versa. Brad Simpson, Chief Wealth Strategist, TD Wealth, talks to Kim Parlee about the importance of using both active and passive management styles alongside less traditional asset allocation strategies.
So before we get into the debate on investing.
Refresh us. What is the debate--
--around oxygen and Everest?
Well, I think the debate-- let's call the summit of Everest 29,000 feet, for simple, round numbers. You get to 26,000 feet-- from 26,000 to 29,000, the air gets really thin.
It gets difficult to breathe. Couple bad things happen along the way. Your body starts to break down. And perhaps even more scary for our analogy is your ability to think starts to decline.
So the solution is liquid oxygen, right. Put an oxygen tank on your back, just like you'll see with a scuba diver. And that takes that away or makes it far easier.
Now, for purists, about 3% or 4% of the climbing community, the great challenge is to be able to make it to the summit without the use of oxygen. And somehow, from that, coming from a born-and-bred West Coaster, is a more au naturale experience.
Right? And that's really what the debate is all about.
Right. And you highlight in here, too, is really maybe it shouldn't be a debate. It's not this or this. It's like, use both.
Yeah. Yeah. I mean, I think that the debate, I think, by the majority, if you will, is that you're going to have that au naturale experience climbing. But you're also going to use human ingenuity, as well. You're going to use all the appropriate gear that you're going to need to increase the odds that you're going to make this out-- make it to the summit in a safe way and make it back down again. And oxygen, for most, is going to make a lot of sense.
So it's that enjoying that moment in nature. You can also have too much, right? And so it's finding that balance between the two.
Now you take this, again, and try and overlay this on the active versus passive approach to investing.
So tell me, how does that compare to Everest?
Well, I think that really, in essence, a passive investment and the way we access them through an ETF--
--says that the market itself is nature, right? And its movements in nature are really all that you need to be able to experience. And from that, maybe weather will come and go. But all in all, if you remain participating in nature as you climb up this mountain, that's really all you need. And you'll get to that destination.
And my analogy really says that that may be true. But a lot of other things can go wrong along the way. And so the human ingenuity part of this in the climbing is the gear and the ladders and all those things.
And the oxygen.
Of course, and the oxygen. And when it comes to money management is that I think an excellent way is to have passive investment strategies that are just participating in the natural order of the financial markets but being incredibly mindful that things can go wrong, that things get mispriced, that there's bad times, and that human--
There's bad weather. There's steep rocks.
There's all that stuff because--
--nature's great when it's going your way.
And it's horrible when it's not.
That's right. And so for the human ingenuity in financial markets is that there are many things that we can do with portfolio management strategies that will reduce the risks of financial market weather.
Right? And also take advantage of those things. And so we've gone through a long period where we've really had some really wonderful weather, and really suggesting. So during those times, after a awhile, you just kind of start to forget that there's bad weather sometimes.
And there is.
And there is sometimes.
So I think it's a good analogy for that.
And it's interesting, too, because we'll get more into this. But you talk more about how this isn't an either/or choice. It's both. I mean, there's some things that make sense, and then the other.
But you also talk about the fact that far too often, the risk side of the equation, which, when I think you have a lot of good weather, is lost in popular investment culture. You've got some interesting survey numbers about what people think about risk in the market right now, which are kind of incredible.
Right. Well, one of the things that reminded me when I first--is that as a young guy working in the investment business in the early '90s-- and that's really when mutual funds really took off. And I would talk to investors. And I would hear from them. And I would hear things like, well, gee, I would never invest in the stock market. And then I would look at it. But I'll invest in a mutual fund.
Which you're scratching your head.
Right? And then I'd look at the mutual fund, and it would be a mutual fund made up of stocks.
Well, that's essentially the market.
And so there's this asset management company, Natixis, a global asset manager, and they do a survey of individual investors and institutional investors every year. This one was 2016.
And one of the things in the surveys they were asking about was attitudes of individual investors around ETFs. And some of the things that were coming out of this were things along the lines of 60% of the people saying, well, that this was actually reducing risk in my investments. Well, but it's an outright investment just in to the equity market, right?
So when you read a survey like that, and you see those sort of things, it makes you stop for a second, right?
And you're wondering, uh-oh. Did you really understand what this vehicle is?
Right. You and I talked earlier. And I know you said, one of the things that-- it's not to say the passive is not a good strategy for some parts of portfolio. But if you have a goal-based portfolio, or if you have places specifically you're trying to get to, you need to construct it properly to get to the goal because, again, if nature happens--
Yeah, for sure.
--it may not.
Yeah. And I think that's a great point, that most of us have our own outcomes that we're looking for. And we don't have an endless timeline for our investments, right? So we can build-- and we do. You build investment portfolios where you are just harnessing the nature, if you will. And we think that there's a lot of instances where that makes a lot of sense.
But if you're starting to get closer to the end of a goal where you're going to want to have the use of your funds, you also want to have some risk-mitigation strategies that will go to make sure that the money that was growing for you is going to be there in the end.
This brings us back to the chart. And we'll bring it up. We've talked about it before, about new ways to think about asset allocation. And tell me a bit about, just in terms of the chart, from this conversation, how this applies.
Well, I think this applies is in-- one of the things that I think is a good example is looking for trying to get exposures to things, and how do you go about doing that.
So I'm always talking about if you have your equity-factor risk or your fixed-income factor risk and allocating based on that. So when, back in November, after the US election, that the Wealth Asset Allocation Committee, we came out, and we said, well, we wanted to increase our exposure to the United States. And we wanted to do so in two ways.
First, all we want to do is increase our equity-factor risk, just that money would start flowing into US markets really indiscriminately, just to be there to get access to that.
The market will rise, yeah, right.
The market will rise. So we made an allocation into the S&P 500 through an ETF.
And that made an awful lot of sense. The other component to that is one of the things of the risk factors I'm saying we always want to manage is liquidity because liquidity can be a very helpful thing to your portfolio, or it can also damage your portfolio. So one of the things we said is that you want to use an active money manager to get exposure to more of your small and mid-cap, more of your liquid type of names.
They tend to be more sensitive to the economy. They're also more sensitive to movements of how their earnings are, and what their price to book is, and their dividend, and their business, and all those things that impact a company. An analyst and a portfolio manager doing research in that area can add a huge benefit to the portfolio. So in there, we're getting equity risk, but we're managing liquidity risk at the same time.
Brad, illuminating, as always. Thanks so much.