Must Lose? Really? Must?

IndexUniverse posted a series of articles asking six people, including Jack Bogle and Jeremy Siegel, whether buy and hold investing is dead or not. One of the six was Larry Swedroe who said something that I want to examine a little closer. I realize that disagreeing with someone like Swedroe draws criticism but this is worth exploring nonetheless.

Swedroe cited a paper by William Sharpe called The Arithmetic of Active Management. There was no link in the article and I have not read the paper in question. Apparently Sharpe said "that active management must lose in any environment or any asset class" and Swedroe believes in the work behind that conclusion.

Again, having not read the paper and whatever criticism that may draw out the idea seems to be academic to the point of having no real world application. This is not to say beating the market is easy because I don't think it is but you know the names of people with long term track records for beating the market, there are plenty of them. They do not make up the majority of participants but must lose, no there are plenty of successful participants.

Some very simple examples that require no real acumen just vague following of current events; For someone who benchmarks to the MSCI EAFE Index the iShares EAFE Fund (EFA) goes back on Yahoo Finance to August 2001. Since that presumed inception through yesterday's close the fund is up 32.8%. Japan, which is one of the largest component countries at 21% of the fund is up 9.8%--Japan measured by iShares Japan (EWJ). The simple act of recognizing that Japan had big problems and omitting it from the portfolio and keeping every other country would have lead to a very long term out performance and again just one simple action.

Another example; In the last five years, a little less time than when the financial sector grew to 20% of the S&P 500, the Financial Select Sector SPDR (XLF) is down 52.9% while the S&P 500 SPDR (SPY) is down 7.3%. Again the simple act of omitting one sector would have made a colossal difference. Anyone so inclined to do the math for either or both examples it would be much appreciated.

The reason I picked these two examples is because I have been writing about completely avoiding Japan from the start of this site and about underweighting (as opposed to omitting) financials since the beginning of this site. Neither idea is trade-intensive but very effective and, if I've been writing about them for a long time, not difficult to isolate. Must lose? No.

Hussman frames this in a way that is far more practical and I believe he has influenced how I do things to an extent (to an extent in that his analysis seems to have far more moving parts). There are times where risk/reward for a fully invested portfolio in equities is simply less attractive. When the risk/reward is less attractive having less exposure becomes prudent. It does not mean you will be right every time but that does not have to be the goal. Sidestepping one horrible event in a lifetime can add a lot of real value to a lifelong result. For many people this sort of context becomes a more realistic way to assess the active/passive debate for themselves.