Voices: Active money management isn't going to disappear
There's a line of argument in the financial press that suggests that active money management is dying, a victim of high fees and underperformance versus low-cost indexing that captures average market returns.
Newsflash: This is anything but the case. Active investing still dominates asset management around the world, and less than “18% of the global stock market is owned by index-tracking investors,” according to a 2017 BlackRock analysis. That is a modest share and a clear sign that active asset management still dominates the industry.
Despite my being mostly in the low-cost, passive camp, I have not been convinced yet by one of my favorite researchers, Jim Bianco, that active asset management is "no longer a viable business model."
Indeed, there are many niches where active managers can prosper.
The history of investing is, by definition, the history of active management, for the simple reason that indexing didn't exist until relatively recently. If we use mutual funds as a proxy, we see that active management was the only investment methodology for almost the entire past century.
I have discussed some of the issues confronting active managers recently. It is reasonable to expect active management to continue to morph into something different from what it is today. The question before us is what active fund management is likely to look like in the future.
A bit of context: The mutual-fund concept traces back to the Netherlands in the late 18th century. In the U.S., pooled investments emerged in the late-19th and early-20 centuries. Massachusetts Investors Trust traces its history back to July 15, 1924, and is still in operation today, managed by MFS. Vanguard's Wellington Fund was founded in 1929. Broad diversification, daily liquidity and professional management were the main attractions for investors.
The activity began last Friday when 6.4 million shares hit the tape, fueling a record daily inflow for the fund.July 29
The new data will allow retail investors to better compare active and passive funds.April 5
Two caveats to consider: I presume we will continue to see fees decline and lower costs across the board for investors. Indeed, I have made the claim that active versus passive debate is really a debate over expensive versus cheap.
Consider the following five areas as potentially the future of active-stock management:
1. Quant driven funds: The ability to sift through enormous amounts of data to identify where performance gains might be found has attracted lots of attention. Some have called it the future of Wall Street; others, the future of asset gathering. Regardless, the underlying technology continues to drive lots of bold and innovative investigation. From natural language analysis of social media to scraping satellite data of shipping movements to other alternative data sources, this is an area that continues to experiment with new ideas.
2. Factor investing: We have discussed various aspects of this, from smart beta to the traditional Fama-French models (listen to my interview with Rob Arnott of Research Affiliates for a detailed explanation). The academic literature on the topic of market performance implies a series of selection factors that drive portfolio returns. Investors can purchase systemized versions of fundamental-based indexes, or as Cliff Asness of AQR Capital Management has noted, factor-driven strategies. These tend to do as well or better than traditional stock picking, and typically at a lower cost. It is not quite indexing, but not quite traditional active management either.
3. High active share portfolios: If you want your portfolios to beat the market, then they should not look like the market. Many people have argued this point, but none more eloquently than the legendary Bill Miller. His run of 15 straight years of beating the S&P 500 is one of the most famous investing streaks of all time. Miller argues that investors have figured out that 70% of all active managers are “benchmark huggers” ― meaning they mimic the indexes while charging higher fees. Investors should either move to pure passive, or if they want an active manager, find someone with a high active share.
4. Niche alpha: The markets are filled with lots of inefficiencies that can be mined for alpha by insightful managers. The challenge is that these areas are not all that scalable. In other words, once the inefficiency is identified, it tends to disappear. Microcap stocks are the classic example of this, but there are many other areas where managers find success.
5. ESG: Despite all of the media attention on environmental-, social- and governance-based investing, this area is still a modest portion of total assets under management. However, there are two data points that imply this may change during the next few decades. The first is the $31 trillion generational wealth transfer that is likely to occur during the next 20 years as the baby boomers retire, and shuffle off this mortal coil. They are likely to leave their money to their spouses and children. Not coincidentally, the biggest supporters of ESG investing tend to be women and millennials. There is a not-insignificant overlap between these two groups.
My Bloomberg Opinion colleague Justin Fox notes there is an economic role for finance beyond pursuing alpha, or market-beating performance. He quotes Burton Malkiel, author of the classic "A Random Walk Down Wall Street," who notes: “There are lots of services that can be provided that aren’t stock-picking.”
I agree with Fox that the traditional pursuit of alpha has been under assault by low-cost indexers. Indeed, my personal portfolios, just like those of my clients, are mostly invested in inexpensive indexes from Vanguard, BlackRock, Dimensional Fund Advisors and Wisdom Tree Investments. However, I am less certain that active managers will not be able to adapt to changing circumstances.
They just might control a little smaller portion of the total assets invested around the world.