The debate that just won’t die…
It is a debate that has (seemingly) raged for as long as England have successfully avoided the later stages of international football tournaments, but is the active versus passive fund management argument finally reaching a conclusion?
The answer, of course, is probably not – like trench warfare, the combatants on both sides are too fixed in their positions to capitulate easily now – but recently there has been a noticeable escalation in hostilities.
First, in April, Ignis Asset Management published research which torpedoed the idea that the RDR would trigger a dramatic increase in the use of passive funds. Not only did nine in 10 IFAs polled say that UK passive funds were riskier than investors realise (prescient in light of BP’s recent experiment to see if it could halve its share price faster than it could pollute the entire Gulf of Mexico), more than two-thirds said they had no plans to increase their use of passive funds following the RDR – indeed, one in 10 planned to use them less.
Today, however, came the counterattack. According to a report by Citigroup, Principal Global Investors and Create Research, the investment industry is set for a ‘massive rebalancing’ from active to passive fund management, amid mounting disillusionment about active managers’ ability to beat benchmark indices. Indeed, Create’s chief executive is quoted in FTfm predicting that the proportion of global assets being managed passively will rise from 15% to 25% in the coming decade, led by sovereign wealth funds, Australian pension funds and – weirdly – US retail investors, who have pulled vast sums from active funds in the last two years and thrust it into the grateful hands of passive managers.
So, case closed then: passive funds are, finally, set to claim the spoils of war (or at least a much greater percentage of them). Except that they, er, aren’t. Citigroup’s research also predicts that by the middle of the next decade, the volume of money being run in a passive index-tracking style could be so great that attractive opportunities will emerge for active managers (due to the extreme price anomalies it would create), potentially reversing the flow of assets from passive to active funds. In other words, passive funds could become victims of their own success. (Interesting to note that passive managers like Vanguard, whose entry into the UK retail market awakened the temporarily dormant active versus passive debate, are suggesting we are a long way off a situation in which the size of index assets influences market pricing.)
Nonetheless, there are plenty of active fund groups out there who would privately admit that the wind is blowing in favour of passive funds. Their counter (i.e. public) argument is usually this: yes, of course passive funds will grow in popularity, but active managers who consistently deliver excess returns will always be worth paying for. If you consider a fund manager like Barry Norris, whose Argonaut European Alpha fund is top decile over every relevant period since launch in 2005, that argument is difficult to refute.
But are we missing something here? Very little of the research in this area appears to explicitly address the market and macroeconomic environment in which funds and fund managers operate. Passive groups suggest investors are disgruntled with active performance, and there is little doubt that is true. But is poor past performance necessarily a guide to future underperformance? Professional investors tend to think not. One leading multi-manager I recently spoke to suggested that, over the medium term, markets will become more focused on fundamentals rather than short-term macroeconomic news flow. Markets will therefore reward companies who can grow in a low GDP growth environment, which suggests that, in the coming months and years, the good stock pickers will outperform their respective indices. If you believe that argument, then we could potentially have a situation in which global assets flood towards passive managers just when good active management comes to the fore…..