Active and passive components of investment or trading strategy
There is a lasting debate about pros and cons of active versus passive investing. Yet it is clear that there are both active and passive elements in any strategy, at least due to the fact that the investor has to decide when and how to initiate, reallocate or withdraw investments at different points of time. Each person has a balance sheet which she manages consciously, systematically, or otherwise. A brief review here[1].
In the context of active (or retail) investor, there is definitely a burden of proof and having an edge for the active strategy because it has necessarily higher costs than index, factor or passive strategies. The principal-agent[2] aspect is important here, namely, that the investment manager (agent) and the investor(the principal, the capital owner) should align their expected utility functions and behavioral biases. There are also aspects of diversification for large institutional investors, for instance, investing into hedge funds.
The active-passive problem is akin to mind-body[3] problem. Active and systematic/passive elements influence each other and evolve similar to the interaction of the mind and body. To this philosophical point - ".... according to Searle then, there is no more a mind–body problem than there is a macro–micro economics problem. They are different levels of description of the same set of phenomena. ..... The Buddha did not make a distinction between the mind and the body and taught that the world consists of mind and matter which work together, interdependently."
What ultimately of interest to me is how to combine active/discretionary and passive/systematic elements of any strategy? How should the behavioral biases and heuristics interact with a systematic strategy? In history and depending on their circumstances, different people organize their mind-body problem differently. Depending on the capital constraints, expected utility and, perhaps mainly, on their inclination, different investors choose different approaches. In the attached paper, Bill Ziemba "The Great Investors, Their Methods and How We Evaluate Them: Theory" classifies the successful investors into five groups 1. Efficient markets (E) 2. Risk premium (RP) 3. Genius (G) 4. Hogwash (H) 5. Markets are beatable (A). The experience matters and varies, see, for instance, the books by George Soros[4] and Lawrence Creatura[5].
articles
Selling Fast and Buying Slow: Heuristics and Trading Performance of Institutional Investors