An investment philosophy is a guiding set of principles which the firm adheres to in providing investment advice to its clients. An investment advisory firm must have a clear sense of their own investment philosophy. What is important to the firm as an investment adviser and what does the firm believe are appropriate rules to follow when investing? What is the firm’s philosophy with respect to risk, diversification, timing, buy and hold, costs/ fees etc? One of the most important aspects of an investment philosophy is the firm’s view on active versus passive management.
Equity markets are generally considered to be informationally efficient, which means that all relevant information is reflected in prices. Because it is difficult for an active manager to generate returns in excess of the market’s return after an adjustment for risk, a common prescription is to turn to passive management in the form of index or exchange traded funds.
This is a sensible approach for many investors. But the case for passive management has logical limits, not least the fact that the more investors embrace it, the less effective it becomes.
Equity market efficiency is a process, not a condition of the markets, i.e. markets approach efficiency over time and may even spend the majority of time being efficiently priced. Stock market inefficiencies do exist, particularly when diversity of thought breaks down (e.g., investors panic or get greedy all at once), as well as when the time horizon extends beyond the market's often myopic frame.
Whatever about the debate around whether or not these inefficiencies are systematic or not, there is a case for active management.
iCubed assists Financial Advisory firms in documenting their investment philosophy. This provides much needed consistency to the financial advisers in the investment advice given to their clients. iCubed is not dogmatic in relation to what a firms investment philosophy should be. But it is a necessary first step in implementing a robust investment process.