I first heard Burton Malkiel speak in 2001. Back then, he was keynote speaker at Canadian Investment Review’s Risk Management Conference and his talk revolved around his now iconic investing book, A Random Walk Down Wall Street. First published in 1973, the book presents a powerful case for passive investing over active management. As he argued in his book, two-thirds of active managers underperform their indexes every year. And of those who do outperform, the likelihood that they can keep it up is even lower.

Of course, his keynote address happened way back in 2001 and hinged largely on the role of the efficient market hypothesis—a concept that has been challenged and criticized in the 10 years since I first heard him speak, particularly in the wake of the financial crisis.

But efficient market hypothesis aside, Malkiel’s work is actually more relevant than ever, especially as the dual forces of product innovation and technology together change how investors are able to access markets. Since 1973, the shape of the market and the role of small investors have been transformed. Investors are now able to access markets more easily and cheaply with tools such as exchange-traded funds. Which is why Malkiel’s updating his book. The latest version will reflect the fact that liquidity, access and costs are all increasingly important not only to retail investors but also to institutions, as the recent data from Greenwich shows. According to ETF.com, Malkiel’s 11th edition of the book will include a section on exchange-traded funds (ETFs) and addresses and contact information for ETF sponsors.

What will be most interesting is how Malkiel addresses the next phase of ETF investing—products with an active tilt based on different factors such as size, value, momentum or quality. As ETF sponsors offer cheap and liquid access to active management, the lines between traditional passive and active are being blurred.

Malkiel’s original thesis is somewhat predicated on the fact that the cost of active management impacts their performance over time, making low-cost index strategies appear more attractive. So what happens to the argument when active management comes in the form of index-like products that are cheap and liquid?

In a recent Q&A with Canadian Investment Review, Malkiel tackles the concept of “smart beta.” As he notes:

“Smart beta has become a very popular investment technique, and there have been many funds and exchange-traded funds that have relied on so-called smart beta tilts to the portfolio. My views are, first of all, that this is active management, not passive investing. Secondly, to the extent that smart beta techniques lead to higher rates of return, they are simply a reasonable compensation for the extra risk that has been taken. It’s not a real new paradigm, a great new investment technique that will dominate straight passive index investing.

The bottom line to passive investors: don’t let smart beta trip you up while out on your random walk. Stay the course; keep your eye on the prize.

I’ll get a chance to hear more from Malkiel next month when he delivers another keynote speech at Canadian Investment Review’s Investment Innovations Conference. I think he will have a lot to say about the encroachment of alpha into the beta world and what it means for investors. Stay tuned….

Copyright © 2018 Transcontinental Media G.P. Originally published on benefitscanada.com

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