The death of active management has been greatly exaggerated



It’s no secret that actively managed funds are struggling (APPENDIX 1). In the three-year period ending April 30, actively managed mutual funds and U.S.-domiciled exchange-traded funds had collective outflows of nearly $ 514 billion. Passively managed mutual funds and ETFs raised nearly $ 1.57 trillion in net new money over the same time period. What started as a more demanding selection of positions in underperforming US equity funds has become more prevalent. For example, in the 12 months ending Jan. 31, investors withdrew $ 99 billion from funds that beat their Morningstar Category Indexes in the same time frame.1

Are we nearing the end of the days for active management? I do not believe that. In my opinion, active management will never die. There will always be investors who hope for something better than getting the net market return for a small fee – it’s human nature. But active management must continue to evolve. Here, I’ll take a closer look at two ways active management has changed in recent years, as evidenced by:

1 Growth in the active use of passive funds.
2 The expansion of a class of nominally passive funds that make active bets.

These two phenomena show that active management is alive and well and that the distinction between assets and liabilities is more blurred than ever.

Investors become active with liabilities
The objects of decision-making for many active managers are changing. Instead of choosing between Coca-Cola KO and Apple AAPL, many active managers choose between US large caps and emerging market debt denominated in US dollars. These active asset allocation decisions are increasingly implemented using ETFs and index mutual funds. The managers who make these decisions do so in a number of different contexts and with varying degrees of activity. These range from widely diversified strategic asset allocation models that are managed in the home offices of intermediary platforms to so-called robo-advisors and ETFs. Among these players, the preference for the passive is strong. In trying to generate alpha by recombining various beta building blocks, many asset distributors want to own all active decisions rather than outsourcing them to a traditional security selector.

The growth of these model builders is most easily measured by the increase in assets under management of target date funds, assets under management or advice in portfolios managed by ETFs, and the amount of money managed on digital advisory platforms. (aka robo-advisors).

The assets of target date funds domiciled in the United States were $ 880 billion at the end of 2016.² Of this, 39%, or $ 343 billion, was invested in target date series that exclusively use passive funds. The market share of these series in the target date market increased from 17% 10 years ago. ETF-managed portfolios are investment strategies that typically have more than 50% of the portfolio’s assets invested in ETFs. Primarily available as separate accounts in the United States, these portfolios represent one of the fastest growing segments of the managed account universe. As of December 31, Morningstar was tracking 881 strategies from 162 companies with total assets of $ 84.8 billion in this space. This is only the tip of the iceberg, as there are tens of billions of dollars invested in similar strategies which are managed by teams on a number of different middle platforms, which are not captured in our database. Finally, there are robo-advisers. Companies like Vanguard and Charles Schwab SCHW have seen rapid growth in the adoption of their digital consulting platforms. Schwab Smart Wallets housed $ 16 billion in investor assets at the end of March. Vanguard’s personal advisor services segment now oversees more than $ 50 billion.

As individuals and advisers show an increasing preference for solutions over products and become more comfortable with technology, it is likely that these active asset distributors will continue to attract new capital from investors. investors.

Actively managed mutual funds also make greater use of passive funds, and ETFs in particular (APPENDIX 2). Since 2006, the number of actively managed mutual funds domiciled in the United States with at least one ETF has more than doubled. During this time, the size of the median ETF positions held by these funds has almost quadrupled. Stock pickers use ETFs to fill gaps in their portfolios. Some have substituted them for futures contracts to capitalize cash. Others invest there to take sector bets when they do not have the expertise to select the stocks at the most attractive prices in a corner of the market. The growing use of ETFs by active fund managers is a clear example of the increasingly blurred distinction between assets and liabilities.

The most striking data demonstrating the active use of passive building blocks is the stock turnover rate of many ETFs. SPDR S&P 500 ETF SPY is the most actively traded security on the planet. According to NYSE, SPY’s average daily revenue in March was $ 21.4 billion. In the year ending April 30, SPY’s average holding period was 15.4 days.3 It hardly seems passive. ETFs are used in countless ways by countless market participants. For some, they are inexpensive, tax-efficient, buy, hold, and rebalance building blocks. For others, they replace a derivative, a trading tool or a hedge. Unlike mutual funds, there is no way to track ETF users or discern how they are used. Trying to do this is like playing a frustrating game of Clue. All we know for sure is that the candlestick was the murder weapon (SPY, in our case). We have no idea who committed the crime, why they did it, or in which dark corner of the mansion the act was committed. What we can say with certainty is that ETFs are actively used (APPENDIX 3).

The passive itself becomes more active
Not only are investors actively using passive funds, but the nature of passive funds is also changing. Asset managers seek to marry the best traits of assets and liabilities, combining active bets with the strict discipline and lower costs of an index approach (APPENDIX 4). This has resulted in a growing number of strategic beta ETFs (aka “smart beta”) and substantial growth in the assets of these funds. Since the launch of the first generation of these ETFs in 2000, their collective assets under management had grown to $ 556 billion by the end of 2016, after increasing at an annualized rate greater than 40% during that period (APPENDIX 5 ).

These funds make active, rule-based bets against the market in a nominally passive manner. Unlike traditional actively managed funds, there is no ongoing research or overnight buy, sell or hold decisions made in response to changing markets. As these are active bets, these funds offer investors the opportunity to outperform, less risk or a combination of the two compared to owning the market as a whole through a capitalization weighted index fund. stock market. It also removes a significant risk from the table – the manager’s risk. The omission of the uncertainty associated with the human element of active security selection is an important distinguishing feature. Additionally, since these strategies are provided through an ETF, they may be more tax-efficient than traditional active funds. Most importantly, however, is the fact that these funds tend to charge lower fees than most of their active peers.

Make no mistake, strategic beta and other similar factor-based approaches to portfolio building are a form of active management. Thus, unlike traditional active funds, not all will succeed in generating better risk-adjusted returns compared to regular market capitalization-weighted index funds over the long term. And like the best active managers, these funds will experience performance cycles marked by droughts and above-market returns. Thus, investors’ patience will be tested and their behavior may be suboptimal. We have already seen examples of all too familiar performance-seeking behaviors among investors in these funds. The active decisions that matter most remain those made by the end investor.

I am not dead
Active management will never die. It will continue to evolve, we hope for the best. Fees will come under pressure, and the terms of the fees themselves may change as well. Outperformance commissions and loyalty programs are among the ideas discussed by fund sponsors. New classes of shares and types of products are also entering the market.

Active managers can also become more active. The exodus of actively managed funds has disproportionately affected funds that are hugs of high-priced benchmarks. Taking more active risk is the only way many managers can justify their current fee levels. The shift to liabilities and the growth of Strategic Beta and other factor-driven funds will drive the evolution of active managers and further reinforce the fact that active and passive become more and more indistinguishable day by day.

1 Ptak, J. 2017. “Without love: Even winning funds bleed assets” Morningstar. March 28, 2017.

2 Holt, J. 2017. Morningstar Target-Date Fund Landscape 2017.

3 I calculated the average holding periods of ETFs as follows: Average holding period = 365 / (Total dollar value of transactions in the past 12 months / Average daily assets under management).

This article originally appeared in the June / July 2017 issue of Morningstar magazine.

Source link


Comments are closed.