King's College London

According to Morningstar, at some point in 2019, the proportion of the US stock market held by passive index tracking funds will tip over the 50 per cent mark for the first time. 

Speaking as part of an expert panel at our recent Conference on Financial Markets, Giuliano De Rossi, Executive Director at Goldman Sachs and Iuliia Shpak, Quantitative Strategies Specialist at Sarasin & Partners LLP shared their views on the active versus passive investment debate:

 

Is the distinction between active and passive funds still a useful one?

Iuliia Shpak: I think we should take a fresh look at how we classify different strategic approaches.  By convention, passive strategies take long positions in market-capitalisation based indices.  But now we are seeing supposedly passive investment products that actually incorporate different kinds of factor strategies like growth strategies targeting undervalued securities within a particular index.

For me, it would be more meaningful to define a strategy not by the type of product that’s used, but to consider whether an approach is driven purely by quantitative models, or where the fund manager has discretion.

Giuliano De Rossi: It is true that a lot of the products we call passive are actually blended. However, the advantage of a true active approach is that they can switch between being fully active when they  see the opportunity, and use a passive approach to stay in the market when they feel it’s best to stay more on the sidelines.

 

Can active strategies consistently beat the market and justify the fees?

GR:  Given the relatively recent explosion of passive approaches and products, much of which has taken place after the financial crisis, we don’t really have enough data to be definitive. 

The most recent evidence suggests that active managers aren’t consistently beating the benchmark, but we have had almost a decade of rising markets. Certain market phases don’t favour the greater concentration to a smaller number of stocks that you’ll see in an active fund.  Right now, you’d expect that volatility will mean that there’s more opportunity for research-driven active stock-picking approaches.

We’re also seeing active investors looking to make more use of the bigger and more varied datasets that are available now to inform their approaches; but it will take time before we can see what returns they are able to deliver from that.

 

How focused are institutions on the details of the different investment styles on offer?

IS: Very focused, and that’s a result of their experience of the financial crisis.  Institutions had felt that they were well diversified, geographically and across different asset classes.  When the financial crisis happened though, assets tanked and they tanked in sync, and they want to avoid repeating the impact that had on their returns.

 

John Bogle, the founder of Vanguard, who is credited as the inventor of the first index fund, warned that ‘If everybody indexed, the only word you could use is chaos, catastrophe’.  Do you think we are nearing that kind of saturation point?

IS: The market might look crowded, but I am not sure that we are there yet.  When it comes to these hybrid strategies, there are often multiple funds that are all labelled as doing the same thing, but if you look closely, they don’t all perform the same way, so they can’t all be mirroring each other.  

There’s also still scope for funds with different ethical filters and goals – for example specific climate changed focussed funds, and for different types of active ETFS.

 

What does the future hold for active managers?  Will we continue to see investors moving more into index funds in order to keep fees down?  And can fees go any lower?

IS: Long term institutional investors tend to think in terms of the core strategic investments they hold for the long term, and their tactical pillars.  I expect we’ll see them continue to make that core strategic allocation through lower cost products and indexed strategies while active strategies such as for example thematic portfolios should provide exposure to idiosyncratic risks.

GR:  As for fees – these things are often cyclical.  Trying to put your fees up when markets aren’t doing well and investors are not happy with their returns, is probably not such a good idea.