It seems across the board pro stock pickers are becoming less and less relevant. This isn't exactly a 'new' trend but certainly one that has been exacerbated in recent years with people pulling their money and placing it in funds which simply mimic the broader market.
It also reflects the fact that many money managers of stock funds, which charge fees but also dangle the prospect of higher returns, have underperformed the benchmark stock indexes. As a result, more investors are choosing simply to invest in funds tracking the indexes, which carry lower fees and are perceived as having less risk.Mutual-fund experts and fund-firm executives said the trend likely accelerated in December. Inflows for ETFs in the U.S. totaled $28.1 billion for the month, up from $20.6 billion in November, according to Deborah Fuhr, a partner at London-based ETFGI LLP.
I wonder what the long term implications of all of this really is. Everyone loves low fees on investment vehicles and considering active management many times provides little to no value, especially in mutual funds, it seems to me their days are numbered. Where is the future of the money management business headed? I can't imagine people would be signing up in droves to self manage their own investments as many people either can't nor have the time to dedicate to it.
So where is the money management industry headed? Are we looking at a trend towards even lower fees and passive management for everything? Vanguard should be eating this up.
The trend towards passive mgmt is mostly cyclical - markets have been much more macro driven of late, which is a difficult environment for bottom up stock pickers to outperform in. Structurally however, fees are coming down for active mgmt. Nobody wants to pay 150 bps for a large cap stock fund anymore.
This has been said forever. Stockpickers, especially value-oriented ones, often underperform when equities rally, unless they are really closet indexers. Much of their value comes in down markets, where capital preservation is extremely important for long term absolute return.
The more interesting trend is ETFs allowing passive exposure to markets where previously you needed an active manager to get access to on a retail level. Fees should fall further, as they basically cover fixed technology costs and as assets increase these costs should be spread, but it depends on whether the growth is coming from new products (which require new investments) or more AUM for existing passive funds/strategies.
If everything were based on an index, then there wouldn't be anybody around to move prices toward the (perceived) intrinsic value. That would actually create market inefficiencies and generate more opportunities for active investment.
False.
Capital allocation / inflows and outflows. Investors can add capital to ETFs or like instruments, which would in turn raise demand for the related basket of equities and push the price up. The reverse holds true in capital flight. Look at the bond markets for a great example of what happens when there's significant capital inflow over an extended period of time.
False.
It would push the basket up and down. It would not adjust the relative weights because the ETF allocates that capital among the individual stocks based on the market cap (usually). In this scenario, market caps would change, but the ratio of the market caps between stocks would not. That's inefficient because relative stock prices would no longer represent the underlying company's perceived prospects. Apple would always be worth more than Google, even if Apple fell apart and Google shined.
There's already some talk related to this. The prevelance of index investing is causing individual stock returns to become more and more correlated, possibly increasing systemic risk.
This trend is most definitely not cyclical. It has been gaining acceptance significantly for about 20 years. Fund flows into passively managed funds have been relatively better, especially for equities and the acceptance is higher the larger in capitalization you move.
One thing of note is that a lot of the 'passively' managed ETFs and funds are just trading vehicles for most people. Think of things like 2X inverse equity returns or ETNs linked to the ViX. These are not buy and hold investments and are radically different than things like the Vanguard 500 mutual fund.
All that being said, the actively managed space is still multiples of the size of passively managed. My guess is that it always will be. The reason is because the average person does not want to achieve average results, which is what an index gives you. People think they can pick outperforming stocks and people think that buying hot funds makes sense, despite the overwhelming evidence to the contrary.
Amen to that - I'll add one thing I've been seeing. From a very large client of mine, his biggest concern is the competition he is getting from his company's OWN ETFs that his company is issuing.
Not cyclical - it's a trend. But there will always be money for fund managers, how many suckers still sending their bank details to some guy in Nigeria; it's a bit the same in markets...
The active management industry is probably too large as it is, although how you'd go about proving that is beyond me. (As a theoretical point, I'm sure there is an 'equilibrium level' for the amount of active versus passive world AUM). To be frank, the active management industry has resisted lower prices for a very long time -- an irrationally long time, really. Fees should have come down long ago. Perhaps this is an example of active managers shedding less 'sticky' money in order to keep their fees high. At a certain point, either you cut fees to become competitive with the increasingly popular 'indexing solution,' or more and more indexing opens up the opportunity for the active managers who remain to have more opportunities for outperformance.
Just sort of musing here.
Are there not funds that consistently beat the S&P year over year, net of fees?
I agree with the notion that over the long-term the overall active management industry shouldn't outperform significantly just because bad funds die and good funds get flooded with assets and their returns go down. But on an EMH level I can't disagree more with the people who argue the overall market is better than an active manager. Not the average active manager, since sadly most fund managers are borderline retarded, but a decent chunk of responsible, intelligent fund managers have consistently obliterated the S&P over 1, 3, 5, 10, 15, 30 year periods. I think one reason you see such horrible results from active management is there's so many different strategies for it that don't work, while passively investing you just get the same blended average over and over.
I hate the theoretical aspect of this (didn't listen in class) but the point I hate people trying to make is that investors can't consistently pick winners. They have, they still do, and they will continue to do so. Problem is the people that do it can't let the entire world into their funds or else it doesn't work anymore.
The odds for a good manager aren't 50/50. Think about Poker: sure, you sometimes get newbies making it far, but great players tend to consistently place in the upper echelons of the most competitive tournaments. There's an element of luck in investing, but by being good, you can significantly increase your chances.
Like DMMSY just said, a concentrated portfolio of stocks is not going to be as correlated to the S&P and can significantly outperform (or underperform) the market accordingly. I can't imagine a scenario where the 50/50 assumption for active managers picking stocks makes any sense, so it's not a stretch to say there's guys out there running 10-20 name portfolios that continually beat the market. And sure, the "like that" probabilities make hindsight seem like 20/20, but when you look at all the managers who are whomping the S&P over 5 and 10 year periods, you'll see a very definitive trend, trust me. The guys are out there, and they all have a few things in common that make them special. Unfortunately one of those things is common sense, which is apparently hard to come across anymore.
IMO I think large asset management firms need to have higher turnovers at the top. I feel some PMs get grandfathered for whatever reason and thus have much less pressure to outperform. I see some PMs at very large AM firms here in Canada with 5+ years of slight underperformance.
I ran the fund screener at Schwab to test the ideas here. There were 618 large cap blend funds that have been around for at least 10 years. The number of funds that beat the S&P 500 TR for each of the 1, 3, 5, and 10 year periods was 22.
22 funds that outperformed consistently/618 total funds = 3.6% that outperformed consistently.
So there are definitely not a large amount of managers that are consistently beating the S&P 500 each year. In fact, this doesn't mean that each of these 22 beat it each year, I'm sure that's even lower. I'm not saying it's the only way to measure their success, but it should be pretty eye opening. I don't know how many poorly performing funds were closed during this time either which wouldn't show up in the data and would make the data look worse. In the absence of proof that someone has about persistent outperformance, the default stance should be that we're dealing with highly paid coin flippers.
(it won't let me post a link to the screener, but you can find it on Schwab's website and run it yourself if you don't believe me)
I wouldn't argue with the notion that most managers can't beat a TR index consistently. But what irks me is the argument that in the event people do it, it's purely a stroke of luck. There are very good investors out there who really don't need luck, though not every highly paid manager is going to be one.
And in any case, 3.6% sounds about right. Most funds aren't even trying to outperform their index by much. Just look at what's happened to the guys that used to be master funds like Magellan... they're glorified total return ETFs now. There's not a ton of funds out there that are picking stocks just based on what they think is good, without mandate, but the ones that do definitely have stock picking prowess and aren't just throwing darts at their sectors.
For anyone interested in reading: http://www-stat.wharton.upenn.edu/~steele/Courses/434/434Context/Effici…
This debate is getting ridiculous. It is clearly a mix of kids who have never been closer to Asset Mgmt than a 101 class in undergrad and those of us who actually work on the buyside.
Yes.
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