"It's difficult, costly and risky to try to beat the markets"

Alexandre Arnbäck is the co-founder of Passive Management SA and a former private banker with Lombard Odier. He is convinced that only a passive investment approach can give optimal performance with the lowest possible risk to private investors.

MyPrivateBanking.com: Why do you call passive investing “the silent revolution”?

Alexandre Arnbäck: For nearly 40 years passive management quietly disrupts the world of finance in demonstrating that it is difficult, risky and costly to try to beat the markets. This inconspicuous revolution, based on the scientific study of capital markets, has revealed the flaws of active management and then found solutions to elude them.

Today, 15% of worldwide wealth is invested passively. This represents 10 times more than all the wealth invested in hedge funds. Everybody has heard of hedge funds before but very few know about passive management. There is no publicity, no marketing as it does not deal with the emotions to convince. This “silent revolution” appeals to common sense.

MyPrivateBanking.com: What exactly is a passive investing strategy as opposed to an active one?

Alexandre Arnbäck: Active management is based on the assumption that investors can beat the market in the long run by cleverly predicting which assets would go up or down. Passive management on the other hand is an investment method, without forecasting, thus eliminating any risk of mistakes.

Passive Management rests of the ideas firstly that stock prices are unpredictable but investors should take advantages of the value creation of companies and economic growth, secondly that return is always proportional to risk, and thirdly that diversification works and is the antidote to uncertainty. In addition, fees matter, lower expenses increase investment returns

Active management uses stock-picking, market timing and manager selection to try to outsmart the markets. However, as markets are efficient, stock prices already reflect all available information; hence it is impossible to forecast changes in a reliable way. All studies have demonstrated that over the short term, 70% of investors do less well than the market average. Over the long term the average investor looses between 3% and 6% each year, whereas only 2% of managers succeed in outperforming it. Passive management takes this reality into account and instead of trying to outguess the markets, passive management takes advantage of the ways markets compensate investors for the risk taken.

MyPrivateBanking.com: Which indices should be the building blocks of a good, balanced passive strategy?

Alexandre Arnbäck: Passive management is not index management and tends to avoid index funds as they present many flaws. In particular, indices
have not been created to invest but to measure.  By reducing their tracking error, they force the investor to buy high and sell low when a stock enters or exits the index. They are expensive because of high transactions costs and they do not provide an optimal diversification. For example, the S&P 500 holds only 500 stocks while over 6’300 stocks are listed on the US stock exchange. And, last but not least, they are used by index managers who believe in market timing.

On the other hand, passive management uses passive funds which minimize turnover and transactions costs and have the flexibility to buy a stock beforeor after it enters an index. So essentially, we use institutional passive funds as our core building blocks.

MyPrivateBanking.com: Why have only so few private investors taken a passive investment approach so far?

Alexandre Arnbäck: In fact, many private investors in the USA and in the UK have opted for a passive strategy today. However, in Continental Europe, there is a lack of knowledge about passive management and very few managers or banks offers this type of services.

MyPrivateBanking.com: You have worked yourself many years for a Geneva private bank; why do you think have wealth managers been so slow to offer passive strategies to their clients and will change that in the future?

Alexandre Arnbäck: Simply because it is not in their interest to offer passive strategies to their clients, as it will reduce their revenue drastically. Today, managers use clients' emotions and markets' volatility to frequently buy and sell investments. Unfortunately for them, with a buy and hold strategy, commissions are trimmed down. In addition, going for a passive strategy is admitting that nobody, even the financial experts, can forecast the future - something that is not always easy to accept.

We believe that this will change in the future as the demand for passive strategy is growing, which is exactly what is happening now in the UK for instance.

Passive Management SA was founded by Alexandre Arnbäck and Trevor Pavitt, two former private bankers uncomfortable with the objective to sell their customers ever more products, increasing profitability for the bank but often disappointing for the investors. Thus they decided to join in binding aims to find the best solution for their customers.

Alexandre Arnbäck holds a MBA obtained between ESADE, Barcelona and Duke University, USA. Alexandre began his professional career in 1996 at LEM SA as head of analytical accounting before joining Darier Hentsch & Cie, later known as Lombard Odier Darier Hentsch & Cie, where he remained as a private banker for eight years.

You can find the firms's diy guide on passive investing here.