The turf war continues

November 23, 2015 08:30 AM

Active managers can’t beat the market!

That’s the message from naysayers of stock pickers as they urge investors to settle for passive index funds and take what the market can give them.

The last several years of loose monetary policy were a boon for index-based funds while active managers struggled to keep up with their benchmarks. Index funds have beaten their active counterparts during most of the seven-year bull market. At Morningstar’s annual 2015 investment conference, the research firm noted that actively managed funds trailed their passive peers across almost every asset class between 2004 and 2014. During that time, capital flows toward lower-fee, passively managed funds have been remarkable. 

In 2004, annual inflows into passive funds outpaced those into active funds for the first time. Since 2009, it has only accelerated. Today, roughly $3.8 trillion in assets sit in active funds while $2.5 trillion are in passive funds, according to a report by CNBC. 

In 2014, active funds saw roughly $98 billion in outflows, according to Morningstar.

On the surface, it appears that passive crowd holds the high ground in a battle that is never short of data.

After all, active management has ceded an immense amount of the neighborhood to the exchange-traded fund (ETF) boom, and concerns about front-running (among other issues) have largely delayed the strategy into these funds. Of the roughly $2.1 trillion spread across 1,750 ETFs, just 1%, or roughly 
$21 billion is in actively managed ETFs. Just $1.1 billion of the entire ETF sector is controlled by actively managed stock-picking strategies. 

The additional benefits of low fees, increased transparency and improved tax efficiency also instill confidence among investors. So too does the support from big-name investors like Warren Buffett, who in his 2013 annual shareholder letter wrote that his wife’s estate employs 90% of its assets to a “very low cost” index fund that he believes will pay better over the long-term than most investors can traditionally obtain.

Morningstar states that just one in five active large-cap equity and blended-fund managers beat the 
S&P 500 Index since 2010. The S&P Dow Jones Indices report card indicates that 86% of active managers failed to beat their benchmarks in 2014.

So how can anyone can defend active investors with these numbers? It begins with the nature of the benchmarks themselves and evolves into a greater discussion on how active managers actually do outperform passive investment.

This month, Modern Trader reached out to experts from across the industry and found compelling arguments for active managers on the real reason why they underperform or outperform the market. In conversations with academics, research leaders and robo-advising experts, we explore why the data skews against active managers, how robo-advisers are finding alpha through active strategies and what the future of passive indexes look like as technology and algorithms evolve. 

As the Federal Reserve is widely expected to take action on interest rates in either December 2015 or March 2016, the end of the zero-interest-rate policy rekindles the debate. Will 2016 create the ideal environment for active management to prove its case as the preferred investment strategy?

Regardless of which side wins the battle, there’s no shortage of optimism for stock pickers. In March, Schroder Investment Management conducted a global survey of investment trends and asked questions to 2,000 intermediaries around the world. It found that equity funds were the world’s most popular investment vehicle. The survey showed that 52% of respondents preferred to recommend active funds over any other instrument.

We step into the turf battle between Active and Passive management and come away with some intriguing evidence that suggests we’re at the beginning of a very good environment for active managers.

 

About the Author

Garrett Baldwin is the Managing Editor of the Alpha Pages and the Features Editor of Modern Trader. An author and Baltimore native, he earned a BS in journalism from the Medill School at Northwestern University, an MA in Economic Policy (Security Studies) from The Johns Hopkins University, an MS in Agricultural Economics from Purdue University.