{"id":67005,"date":"2017-11-15T00:06:34","date_gmt":"2017-11-14T23:06:34","guid":{"rendered":"http:\/\/beta.next-finance.net\/strategie\/will-passive-save-active\/"},"modified":"2017-11-15T00:06:34","modified_gmt":"2017-11-14T23:06:34","slug":"will-passive-save-active","status":"publish","type":"post","link":"http:\/\/beta.next-finance.net\/en\/strategie\/will-passive-save-active\/","title":{"rendered":"Will Passive Save Active?"},"content":{"rendered":"

Indexing Raises the Bar<\/strong><\/p>\n

This month we\u2019re taking a break from global economics and
\ncapital markets for several reasons. First, our views have been
\nwell-covered in this space in recent months. That is, that risk
\nassets will continue to grind higher as long as the synchronized
\nglobal expansion remains on track. Investors should temper
\ntheir expectations, however, as valuations across stocks,
\nsovereign bonds, and credit remain elevated. Simply put,
\nfundamental strength will exert upward pressure on assets, but
\nthe upside is probably limited longer term because no broad
\nasset classes are cheap. Second, little has changed in the big
\npicture over the recent months. The global expansion, slow
\nnormalization from central banks, the on-again-off-again love
\naffair with US tax reform, growing geopolitical risk, and
\nchallenging valuations still define the backdrop for global
\ninvestors.<\/p>\n

This month, instead of a market rehash, we\u2019ll turn to the everpopular
\nactive vs. passive debate.
\nOur objective is not to argue
\nthat one is better than the other \u2013 they both have merit within
\na diversified portfolio of strategies. Instead, we\u2019ll explore how
\nthe growth in indexing is (paradoxically) forcing active
\nmanagers to up their game \u2013 a positive development for
\ninvestors of all stripes.<\/quote><\/p>\n

Active Adaptation<\/strong><\/p>\n

Times are tough for active managers. Regulation, transparency,
\nand cost sensitivity have conspired to shift trillions of dollars
\nfrom active investment strategies to passive indexing. By most
\naccounts, the outlook for active investing is challenged, as
\ninvestors are losing patience with active managers\u2019 prolonged
\nstreak of underperforming the major indexes. In addition, many
\nof these managers continue to charge fees that are significantly
\nhigher than those of the passive alternatives. After 35+ years of
\nbeta-driven returns generating abnormally high profit margins
\nacross the industry, the combination of charging more and
\ndelivering less finally looks unsustainable.<\/p>\n

These are strong headwinds. While active managers have
\nalways competed against each other, they have never had to
\nconfront a threat of this magnitude. But in a strange irony, the
\npressures emanating from cheap passive strategies may
\nultimately save the active management industry. As Darwin
\ndemonstrated, the most adaptable species are the ones that
\nultimately survive. In this case, passive investing is forcing
\nchanges to active management that are long overdue. We see
\nfive trends that should bode well for active managers who are
\nbest able to adapt in the coming years.<\/p>\n

#1: Lower Fees, Better Performance<\/strong><\/p>\n

First, and most obvious, indexing is forcing active managers to
\nreassess the competitiveness of their fees. Going forward,
\nactive managers will have to better align their fees with their
\nability to generate excess return. These downward adjustments
\nwill, by definition, improve net performance (ceteris paribus).
\nRegulatory changes also play a role. Directives like RDR in the
\nUK and proposed fiduciary rules in the US are forcing fund
\nbuyers to purchase lower-cost share classes with many of the
\nextraneous expenses eliminated. In the US, high fee B-shares
\ndied several years ago, while sales of the once popular C-shares
\nare moribund. The truth is that many of these share classes had
\ntotal expense ratios high enough that long-term
\noutperformance was unlikely. The industry\u2019s movement toward
\nlower cost appears well under way.
\nA recent study by FUSE
\nResearch Network notes that average fees for active equity
\nfunds have fallen from 0.92% to 0.75% over the past ten years
\n\u2013 a 18% drop. As active managers continue to cut fees and
\ninvestors demand more stripped down share classes, fewer
\nstructural laggards will be left in the active universe.<\/quote><\/p>\n

#2: Lean and Mean<\/strong><\/p>\n

On top of improved performance, a closer eye on costs could
\nbring additional benefits. We believe lower fee revenue will
\nresult in an era of increased discipline and efficiency for active
\nmanagers. Over the years, high profit margins across the
\nindustry have allowed the focus of active managers to wander.<\/p>\n

Many overinvested in areas of the business unrelated to
\ngenerating alpha, but as margins shrink, the days of industry
\ngiveaways and boondoggles are likely numbered.<\/quote>
\n Revenue
\npressures will force active managers to streamline and focus
\nsquarely on activities that seek alpha. They may increasingly
\nturn to new technologies to reduce labor costs and seek
\nperformance consistency. If adopted, smarter trading and more
\nefficient use of quantitative techniques should lead to lower
\nexpenses and more competitive returns.<\/p>\n

#3: Death of the Closet Indexers<\/strong><\/p>\n

A greater focus on generating excess return will naturally drive
\nmanagers to create more differentiated portfolios. As early as
\nthe 1980s, institutions began to recognize that portfolios could
\nbe made more efficient by separating cheap beta from
\nexpensive alpha. Today, even retail investors understand the
\nperils of benchmark hugging and overpaying for beta, and are
\ngradually forcing the closet indexers out of business. As
\ninvestors barbell between low fee beta and higher fee alpha,
\nthe active funds that remain will be more concentrated and
\nhave less benchmark overlap. While this \u201chigh active share\u201d
\nalone may not be sufficient to generate excess return, it is
\ncertainly a necessary condition.
\nAs a result, fewer strategies that are structurally unable to outperform their expense drag
\nwill remain in the databases. Like lower fees, this third trend will
\nalso improve the relative performance of active managers
\ncompared to their benchmarks.<\/quote><\/p>\n

#4: Is Anyone Paying Attention to Fundamentals?<\/strong><\/p>\n

A fourth consequence of the growth in passive investing is an
\nincreasing misallocation of capital. Counterintuitively, indexing
\nmay be creating greater opportunities for active managers as
\nmore capital is put on autopilot without regard to asset quality.
\nToday, the majority of indexed assets are simply allocated
\nbased on market capitalization (for stocks) or issuance size (for
\nbonds). No distinction is made regarding companies\u2019
\nfundamentals, valuation, risk, or governance practices. While
\ninvestors can expect markets to remain reasonably efficient,
\nthe surge in indexed assets can create larger pockets of
\nmispriced securities. Again, there is no guarantee that the
\nmajority of active managers will be able to systematically take
\nadvantage of these pricing inefficiencies. However, for active
\nmanagers skilled enough to capitalize on it, opportunities to
\ngenerate alpha are likely to increase.<\/p>\n

#5: The Perils of Autopilot<\/strong><\/p>\n

Finally, some active strategies stand to gain from one of
\nindexing\u2019s inherent weaknesses: the inability to manage risk.
\nThe major market-cap and issuance weighted indexes are fully
\ninvested at all times and provide pure beta, delivering all of
\nwhat the market provides, good and bad. Since 2009 this has
\nbeen a boon for passive strategies, as global stocks have risen
\nwhile declining interest rates bolstered bonds. But at some
\npoint the bear will return, and when it does, investors will
\nrediscover the darker side of holding assets on autopilot. While
\nthere is no guarantee that active strategies on average will
\noutperform the indexes in the next big selloff, these managers
\nat least have the ability to de-risk during periods of trouble.
\nIn
\nthe next bear market, many investors who have been spoiled
\nby full upside participation will come to realize the pain of full
\ndownside exposure. As with planes and self-driving cars,
\nenthusiasm for autopilot may wane after the first crash.<\/quote>
\n This
\nmay be when investors develop new respect for the segment of
\nactive strategies that can offer some downside protection that
\nthe indexes, by their very nature, can\u2019t provide.<\/p>\n

Wake-Up Call<\/strong><\/p>\n

None of these factors, individually or in aggregate, insures that
\nthe average active manager will beat the index or outperform
\nnet of fees. However, the pressures exerted by passive indexing
\nare forcing active managers to tackle longstanding sources of
\ninefficiency and underperformance. By setting more
\nappropriate fees and weeding out closet indexers, active
\nstrategies should rise in the competitive rankings. Moreover,
\nthe wake-up call of the next bear market will force investors to
\nbe more discerning about the quality of the assets they own,
\npushing many of them towards strategies that can better
\nmanage risk. <\/strong>
\nInstead of complaining, active managers should
\nembrace the changes occurring in the asset management
\nindustry. In the long run, the competitive pressures of passive
\nindexing may save active management.<\/quote><\/p>\n","protected":false},"excerpt":{"rendered":"

According to David F. Lafferty, CFA\u00ae, Senior Vice President \u2013 Chief Market Strategist at NGAM, the pressures exerted by passive indexing are forcing active managers to tackle longstanding sources of inefficiency and underperformance. By setting more appropriate fees and weeding out closet indexers, active strategies should rise in the competitive rankings.<\/p>\n","protected":false},"author":1,"featured_media":67003,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":[],"categories":[1483],"tags":[1809,1655,1718,1659,1437,1807,2087,2234,2068],"_links":{"self":[{"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/posts\/67005"}],"collection":[{"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/comments?post=67005"}],"version-history":[{"count":0,"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/posts\/67005\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/media\/67003"}],"wp:attachment":[{"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/media?parent=67005"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/categories?post=67005"},{"taxonomy":"post_tag","embeddable":true,"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/tags?post=67005"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}