According to an interesting article by Morningstar, titled “The Death of Active Management Has Been Exaggerated,” over the past three years, ending on April 30, 2017, passive funds grew by $1.57 trillion in total asset inflows while active funds experienced outflows of $514 billion AUM.1
So, is active management dying? Is the world giving in to the idea that Any Monkey Can Beat the Market?
What exactly is active versus passive investment?
Active investing, as implied by its name, involves a hands-on approach and the role of a portfolio manager picking and choosing stocks in an attempt to outperform the average return of the stock market. The objective of active money management is to exploit short-term market volatility. Advantages of active investing include hedging and diversification. Due to the flexibility in picking and choosing stocks as opposed to following an index, active strategies are thought to have a higher level of diversification as well as the ability to exit certain stocks when the timing feels right. .
Passive investing entails the investment in an index fund, such as the S&P 500 or Dow Jones Index. As its name suggests, the strategy is passive because it doesn’t require a portfolio manager to buy and sell based on market changes, but rather involves a buy and hold strategy. Some advantages of passive investing are tax efficiency (such a strategy usually doesn’t result in large capital gains taxes), transparency (when investing in an index, it is very evident which companies and assets capital is being allocated towards), and relatively low fees (passive investment does not require a fee for the portfolio manager picking stocks, as active management does).
So, is active management dying?
The short answer is no. “Active management will never die. There will always be investors who hope for something better than getting the market’s return net of a small fee – its human nature. But active management must continue to evolve.” 1
The article goes on to note two interesting changes that have occurred in the marketplace over the last decade, which has seemingly blurred active and passive management together:
- The growth in the active use of passive funds, and
- The growing amount of passive funds that are making active bets.
This is leading us to next frontier: the growing blend of active and passive investing:
We are living in a marketplace where active managers are increasingly choosing asset allocation strategies based on entire sectors or indexes, rather than individual companies themselves. This is portrayed through the growth in assets under management in ETF (Exchange Traded Funds) portfolios and target-date funds.
(Note: Target Date Funds are mutual funds often used for retirement that have an asset allocation mix becoming more conservative as the predetermined target date nears, e.g. as the investor approaches retirement age.)
ETFs have proved to be one of the fastest growing financial products in the entire investment universe. To date, the number of U.S. actively managed mutual funds containing at least one ETF has more than doubled since 2006. 1
What has caused this interesting blend, you might ask?
…Introducing, Smart Beta.
If beta is now smart, what does that say about the old beta?
You may recall hearing the term “Smart Beta” used excessively in the investor marketplace. It may have led you to wonder if investors were previously measuring themselves against dumb beta. No, not necessarily, but Smart Beta is an evolution of the conventional financial beta, which is the term used to describe the measure of volatility or systematic risk of a certain investment security or portfolio.
Smart Beta, on the other hand, as defined by Investopedia…
“Smart Beta defines a set of investment strategies that emphasize the use of alternative index construction rules to traditional market capitalization based indices. Smart beta emphasizes capturing investment factors or market inefficiencies in a rules-based and transparent way. The increased popularity of smart beta is linked to a desire for portfolio risk management and diversification along factor dimensions as well as seeking to enhance risk-adjusted returns above cap-weighted indices.” 2
What does this mean in the context of investing? Smart Beta investment strategies are a form of active investing that embrace passive characteristics. For example, a Smart Beta investment strategy passively follows indexes, while taking into consideration volatility and various weighting strategies. Smart Beta strategies are different from standard ETF strategies that follow the S&P 500 and other conventional indexes, because these strategies instead invest in particular market areas typically focused on mispricing. This type of investment strategy normally entails costs in-between that of a traditional active strategy and a traditional index investment.
The blend of active and passive investment strategies has actually caused the advent of smart beta. As active managers are seeking to pair the most advantageous characteristics of both active and passive strategies, this has led to the use of Smart Beta. Over the last one and a half decades, ETFs utilizing Smart Beta have grown by $556 billion in AUM.
The article concludes with a reiteration of the notion that active management is not dead.
“The exodus from actively managed funds has disproportionately affected funds that are high-priced benchmark huggers. Taking on more active risk is the only way that many managers can possibly justify their current fee levels. The movement to passive and the growth of strategic-beta (Smart Beta) and other factor-oriented funds will drive the evolution of active managers and further reinforce the fact that active and passive are becoming more indistinguishable by day.” http://beta.morningstar.com/articles/812711/the-death-of-active-management-has-been-greatly-exaggerated.html  http://www.investopedia.com/terms/s/smart-beta.asp