This is probably how the executives of America’s largest money managers felt as they trudged into a meeting last month to discuss the “seismic shift” in the industry. Sarah Krouse at WSJ detailed the meeting and the various approaches managers are taking to try and come to terms with the shift from active to passive management. One likely outcome will be a surge in M&A activity among money managers facing a continued squeeze on profits.
As trends go, this one is pretty cut and dried. Despite the protestations of an “index fund bubble” the only question seems to be where the balance between actively and passively managed assets under management will end up. Rather than going into great depth below are some topics (and recent, relevant quotes) that make the case against active management. I would love to say there was enough material to present a balanced case, but alas there was not.
- Investors pay too much for traditional active management…
- Where mutual funds do add value in excess of market returns, most of this value is consumed in fees and costs. (GestaltU)
“Most U.S. active equity funds failed to beat a relevant Vanguard index fund before and after taxes. This is not an isolated occurrence, as the clear majority of these funds have failed to beat a comparable index fund over most of the 10-year periods we studied. Given these long odds, investors should think twice about putting taxable money to work in active stock funds.” – Jeffrey Ptak (Morningstar)
“The authors have basically discovered that it’s possible for investors to behave like rational performance-chasers. For some reason, they just don’t.” – Noah Smith (Bloomberg View)
“The brave new world of index funds and ETFs eliminates the problem. While index mutual funds must officially report their possessions once each quarter, the underlying index typically reports far more often. In practice, then, the index-fund shareholder enjoys almost full transparency. The ETF owner, of course, explicitly enjoys that privilege, thanks to that investment’s basic structure.” – John Rekenthaler (Morningstar)
“When you combine the style drift results with tracking error at 4%, you have nearly a majority who believe the greatest sin for active managers is violating the modeling expectations of investment consultants. Contrast the investment consultant’s need for stability with the active manager’s need to create strategies that exalt, rather than stifle their capabilities, as well as time for their strategies to bear fruit, and you can see a major disconnect.” – Jason Voss (Enterprising Investor)
Paradox of skill
“Details that were once known by few are now known by many. Progress has occurred. And while this progress represents good news for how accurately stocks are valued, it is decidedly less positive for those professionals who are paid to find mistakes in those values.” – John Rekenthaler (Morningstar)
It’s hard to find many sensible arguments in favor of active management. Eighteen minutes with Charley Ellis, author of The Index Revolution: Why Investors Should Join It Now will put you off active management for quite some time. However Prof. Aswath Damodaran at Musings on Markets notes the conditions under which investors should undertake active investing:
“I have made peace with the possibility that at the end of my investing life, I could look back at the returns that I have made over my active investing lifetime and conclude that I could have done as well or better, investing in index funds. If that happens, I will not view the time that I spend analyzing and picking stocks as wasted since I have gained so much joy from the process. In short, if you don’t like markets and don’t enjoy the process of investing, my advice is that you put your money in index funds and spend your time on things that you truly enjoy doing!”
The problem is that we are talking about an industry, not a individual’s avocation. That being said Joshua Brown at the Reformed Broker recently had six sensible recommendations for the active money management industry that will likely be ignored. These include:
Stop fighting unwinnable battles, be creative, amp up the exclusivity, shrink the industry, educate the investor base and change the conversation about benchmarks. All of these things are doable and worth doing.
Worth doing, indeed. But don’t hold your breath. Milking a cash cow, like actively managed funds, is seductively easy. To completely
paraphrase mangle the words of John Green:
Cash cows die slowly, and then all at once.