Let me start by saying that I believe a low-cost, passive investment strategy based on the tenet of diversification is a prudent starting point for building durable and efficient portfolios. The elephant in the room though with passive investment strategies is valuation. Ignoring near-term market conditions, including valuation, is neither reasonable nor prudent in my opinion. Taking a line from Jeremy Grantham’s latest quarterly note:
Stocks at fair value are less risky than stocks trading 30% above fair value because the expensive stocks give you the risk of loss associated with falling back to fair value … When an expensive asset falls back to fair value, subsequent returns should be assumed to be normal, which means that the loss of wealth versus expectations is permanent.
Consider current valuations in U.S. Treasuries – how does a passive asset allocation strategy contend with the upcoming regime change in interest rates and reconcile rebalancing a portfolio into a fixed income bubble? Investment allocation decisions should not be made in a vacuum and once information is assimilated to make informed decisions – then acting, in what I would consider a prudent manner, can no longer be a passive exercise.