Traditional stock picking and active management of portfolios is more than just a little out of favor these days. An ever-increasing amount of institutional assets are being managed in index funds and indexed Exchange Traded Funds (ETFs), otherwise known as passive strategies.
So why do we still believe in active management?
Ultimately, we believe any investor in a business, either directly or through stock ownership, will be rewarded in time based on the results of the underlying business. We think it is worthwhile and possible to identify businesses that are attractive for investment.
For example, imagine that you moved into a new city with 50 businesses and had $1 million to invest only among those businesses, it seems unlikely that your initial thought would be to invest a little bit of your capital among all 50 companies. More likely, you would take the time to get to know those businesses and the people who managed them. They would be businesses for which you could make estimates of their total value based on their net income, the real estate they own, the capital needed to reinvest in the business and other factors such as those.
Once you did that you would select a handful of those 50 businesses to invest in. You might tend to concentrate in businesses that made sense to you, and that were run by competent people with incentives such as co-ownership to encourage them to work hard on behalf of their investors.
The following quote from a fund manager we respect sums up our view:
We believe we best serve [investors] by endeavoring to own a concentrated portfolio of stocks that has been intensively researched and carefully purchased, in the belief that such a portfolio will generate higher returns over time with less risk than a diversified basket of stocks chosen with less care.