Interview: Charley Ellis, CFA, Speaks Out about Active Management (Podcast)

“The Rise and Fall of Performance Investing,” a recent article by Charles D. Ellis, CFA, in the Financial Analysts Journal, has sparked a lot of chatter in the financial press. The coverage from Jason Zweig in the MoneyBeat section of the Wall Street Journal generated lots of commentary from readers, and MarketWatch is currently running two articles in response to Ellis — one of which has triggered remarks from professionals on both sides of the debate. John Ewoldt of the Minneapolis Star Tribune has weighed in, and the Economist’s Buttonwood Blog cites Ellis’s work in a discussion of the recent FAJ article by Gary E. Porter and Jack W. Trifts. What was it about Ellis’s piece that whipped up such a firestorm?

The crux of Ellis’s argument is that ballooning fees and shrinking returns are spelling doom for the active management sphere — that it’s often not only in the best interest of clients to fire active managers but also in the best interest of the financial community to move toward passive investment strategies. CFA Institute has been (very) vocal since the financial crisis about the need to restore public trust in the finance industry, and “The Rise and Fall of Performance Investing” cuts straight to the heart of the public trust discussion: Are active managers providing enough value to justify their cost?

Charley Ellis says they’re not — at least, not anymore.

I called Ellis for an interview shortly after his article hit the press. I was struck by how much he didn’t want to be the bearer of bad news. He’s very nostalgic for the glory days of active management, and I doubt you could find anyone unhappier than he is to see them go. “It’s a little bit like when you’re working away at a jigsaw puzzle,” he says. “There’s a little bit of sadness that goes with, ‘Oh, that’s the last piece. We’ve figured it out.’”

“I’ve had a wonderful time as a result of the successfulness of active investing,” Ellis says, “and it’s no fun saying, ‘Sorry, guys, this party is over. We have to take away the punch bowl.’” Nevertheless, he sees the writing on the wall: “I believe that the trend toward indexing is in place for logical reasons and is accelerating moderately and is only being held back because we all love the thrill and the fun of active investing and beating the market.”

Ellis echoes several of the major points of CFA Institute’s Future of Finance initiative. “What you’re really buying when you turn to an active manager is the incremental return over and above the market return — and what percent of that is the fee? . . . It turns out that fee is at least 50%, often 100%, often 150% of the incremental value delivered.” That’s not right, he says. “We ought to be candid with ourselves that the business has become dominant over the profession, and we ought to reorient so the profession is ahead of the business.”

“And the profession is, ‘What can we do for clients?’”

To hear the rest of Ellis’s thoughts — including the experience that made him take a second look at active management fees — listen to the full interview above or download the MP3.

You can read the full article on the CFA Institute Publications website.

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