Passive investing (i.e. indexing) has been beaten into our heads as the “best” method of achieving our investment goals. There’s a lot to like. Internal operating expenses are low and, generally, most actively-managed funds cannot beat or exceed their benchmark.

So why not index? Here’s the inconvenient truth. Investors focusing solely on cost and return ignore the very thing they most often claim is of utmost importance – risk. When markets rise investors who index capture 100% of the upside. They must accept that by definition, when markets fall they capture 100% of the downside.

Why does active management struggle? Because many managers lack a fundamental and philosophically sound strategy. What’s more those that prove “successful” may appear as such not because of acumen but for other factors. Successful active management requires a sustainable and repeatable process – one of the things Apollo looks for when we conduct due diligence in selecting managers for our clients.

Therein lies one of the benefits of active management – the ability to apply a sound strategy independent of market levels. Here’s a great example:

Intrepid Endurance Fund returned 1.54% for 3q16. By comparison the Russell 2000 rose 9.05% during the same period. Are the folks at Intrepid stupid . . . or did the 79.5% stake in cash (relative to the 100% stock benchmark) play a factor? What are they thinking?

Cash ended the quarter . . . (at an) all-time high despite new purchases. Aggregate earnings for the Russell 2000 constituents are negative and haven’t been this low since the recession. The “value” (used loosely) of household financial assets versus disposable income is above the last two stock market peaks and any point prior. Social benefits account for a larger share of income than ever before. Corporate debt has doubled since 2007. Household net worth is larger relative to GDP than at any point in recorded history, going back to 1945. Here’s the U.S. economy in a nutshell: record high stock prices, record low interest rates, falling corporate earnings, growing corporate borrowings, and bifurcated incomes tied to government transfer payments on the one end and the over-financialized economy on the other.

Translation: stock prices are not supported by fundamentals.

In short investors are welcome to index. They’re welcome to believe stock prices reflect the “true” value of the issuing companies. They’re welcome to reap 100% of the return and curse the “stupid” active managers. Will these same investors be as willing to accept 100% of the downside should stock prices fall to more accurately reflect fundamentals?

I rise and fall – let me take credit for both.

– Eddie Vedder