Investment professionals often talk about the importance of avoiding market ‘noise’ and, in terms of the passives world at least, I’m beginning to agree with them.
As a financial journalist, I’m hardly well positioned to get sanctimonious about blown up headlines, but my inbox has been full of them in recent weeks.
‘New research reveals fund managers expect huge growth in ETF market’; ‘Global fixed income ETF market will exceed $2trn in next decade’; ‘Gold ETC inflows surge’; ‘ETPs post strongest H1 inflows in history’. These are all titles of press releases I’ve received in the past week, making my job just that little bit easier you might say.
Of course, ETFs/ETPs/ETCs are not an asset class, so there’s no need to beware a consensus in the same way you would, say, worry about a boom in commodities, property or tech stocks. Instead, active managers need to question why these passives are proving so popular.
I recently compiled a list of the largest UK equity funds (excluding equity income) by assets under management. Four out of the top 10 funds in this area are passive with several others adopting a benchmark-orientated approach, including an entry from iShares, and trackers from BlackRock, Virgin and L&G.
It’s a similar story for the best-performing newcomers into the sector (those funds with a track record of under three years, but more than one year), with ETFs from Credit Suisse, Commerzbank, UBS and HSBC all in the top 10.
Alarm bells will call for active managers if they are underperforming their benchmarks – indeed, the FTSE All Share has outperformed the average from the IMA UK All Companies sector over both one and three years. The best performing funds over the past three years in the UK have actually tended to be mid and smaller companies vehicles, areas where trackers are less popular.
Dan Kemp, an independent funds consultant, says the sea change to passives should be welcomed as it indicates an acceptance of the fact that most active managers underperform their benchmark net of fees.
“It seems inevitable that assets are likely to migrate over time to a smaller number of funds comprising of low-cost passive options and those run by the most successful managers,” he says.
“As a consequence, most funds are likely to shrink and many will die. Avoiding these causalities needs to be a key focus of investors over the next few years.
Kemp believes that a rise in the use of passive funds – whether or not it is to the same degree that the headlines are predicting – also indicates a greater emphasis on tactical asset allocation, as investors seek short-term market exposure rather than adopting a strategic investment approach.
A lethal combination
He adds: “This shift in investment attitudes undoubtedly has its roots in the recent market environment which has been characterised by a high degree of volatility and correlation, coupled with low levels of returns. This presents a lethal combination for active managers as it maximises the potential of poor returns for managers who stray from the pack. It is therefore understandable that investors have increasingly shunned active funds in favour of low-cost trackers.”
The problem then for fund managers is they are coming under more pressure to deviate from the index and take steps to really add value, yet style drift and poor returns will come under even greater scrutiny in a post-RDR world.
There’s nothing to say active and passive funds cannot sit side-by-side in a portfolio and, in fact, that’s the way most wealth managers prefer it. Still, the louder the ETF world shouts, the more active managers come under the spotlight for their perceived shortcomings.