Is Active Management Dead?

For many in the investing community, the overwhelming rise in the popularity of index funds has raised serious doubts about the future of actively managed funds. Market trends over the past few years have indicated that the days of big-name active managers such as Peter Lynch may be over, thanks to poor performance and high costs. Earlier this year, Vanguard CEO Bill McNabb weighed in on the debate.

Over the three years ended August 31, 2016, investors poured more than $1 trillion into index funds. Indexing now accounts for nearly a third of all mutual fund assets--more than double what it did a decade ago and eight times its share two decades ago.

By contrast, active management's commercial struggles have reflected its disappointing investment performance. Over the decade ended December 31, 2015, 82% of actively managed stock funds and 81% of active bond funds have either underperformed their benchmarks or shut down.

McNabb, and many investment professionals like him, have suggested that the only way that active management can survive is by significantly lowering costs. High costs often limit a manager's ability to deliver benchmark-beating returns.

**What do you guys think? Can active managers stage a comeback and slow down the flow of money into lower-cost index funds? Or will the ever-growing gap between passive funds and active funds spell the end of active management as we know it? **

From Vanguard

Comments (35)

Best Response
Oct 19, 2017

The dead horse on this one has been pretty sufficiently beaten. See links below.

TLDR: Yes we all agree it is on decline but won't go away. As with most other financial jobs it has gotten more efficient with technology. For retail investors it makes a lot of sense to go passive but for institutional investors active management mostly still makes sense due to scale and fees. In my opinion it will always be a pendulum - currently in passive direction but just wait til you see some real market volatility. Hard to argue with passive when markets are up up up almost 9 years straight.

https://www.wallstreetoasis.com/forums/is-it-wise-... https://www.wallstreetoasis.com/forums/the-purge-a...
https://www.wallstreetoasis.com/forums/future-of-a... https://www.wallstreetoasis.com/forums/how-can-am-...
https://www.wallstreetoasis.com/blog/investors-eat...

    • 7
Oct 19, 2017

I appreciate the response, and thanks for linking the threads. Quick follow-up question though: a lot of finance/investing clubs in college are based on picking stocks and creating stock pitches. Do you see a lot of value in groups like these and spending a lot of time learning about the fundamentals of stock picking? Or do you think these sorts of skills are becoming less relevant to know for careers in finance and it'd be better to focus on developing other skills?

Oct 20, 2017

The core skillset of investing doesn't change - you still need to understand a company's financials and make the case for why you should invest. Doesn't matter if you work at AM, HF, VC or PE. So I do think the clubs are still helpful as they help you make a case for why you should invest in XYZ company. The issue is now that there's more competition for fewer spots. So you need to be better at it, faster at it and more passionate at it than the rest. So I think the focus on other skills should only be to the extent they can enhance your investing abilities. For example, coding could help if it produces a screening process or pulls data from a site faster. Being resourceful goes a long way...

    • 1
Oct 21, 2017
saxxyman:

... just wait til you see some real market volatility. Hard to argue with passive when markets are up up up almost 9 years straight.

Agree 100%.

Oct 20, 2017

The industry headwind is not favorable for active investment management. Lowering fees might might have a marginal impact in the short run, but not effective in the long run. In order to be successful in the long run, an active manager needs to be able to design highly customized, multi-asset class based solutions to achieve their clients' specific investment objectives.

    • 2
    • 2
Learn More

Boost your resume and land a finance job by passing the FINRA SIE. 264 pages & 1981 smart flashcards written by a former 8X top Fidelity instructor. Try it for 0 bananas here.

Oct 20, 2017
Finexpert:

The industry headwind is not favorable for active investment management. Lowering fees might might have a marginal impact in the short run, but not effective in the long run. In order to be successful in the long run, an active manager needs to be able to design highly customized, multi-asset class based solutions to achieve their clients' specific investment objectives.

I think you're slightly confused. In this context this is Asset Management as in "I work for a fund shop." Not Wealth Management as in "I advise retail/HNW/etc. clients." There are rather few multi-asset fund choices outside of the passive/mostly passive target date funds.

    • 2
    • 1
Oct 21, 2017

Let me clarify it for you. Look at the last question posed: 'Or will the ever-growing gap between passive funds and active funds spell the end of active management as we know it?' I addressed active management (not active funds) in my original comment as there is a distinction between Active Management and Active Funds. Your statement about 'rather few multi-asset fund choices' is just not accurate. There are many active fund shops that are expanding their capabilities to the multi-asset solution space as a source of competitive advantage. Based on your comment, I don't get the sense that you are in the investment industry. Would suggest you read up on the latest developments in the industry.

    • 2
    • 1
Oct 20, 2017

My 2cents.

Passive investors rely on the efficient market hypothesis to make above average returns. Active investors make markets more efficient because they look for opportunities, i.e. inefficiencies within the market. As a result, passive investors actually rely on active investors. While active investors don't directly rely on passive investors, one could argue that the more passive investors, the more inefficiencies within the market exist, allowing active investors to strike and make money. This bilateral relationship will never cease to exist.

However, there is currently an unprecedented number of investors on both sides, and the active management space is evidently more affected. I believe this is because there is a critical mass of active investors needed to reach the efficient market hypothesis, but anything beyond this mass is a waste.

    • 1
    • 1
Oct 22, 2017
Whitebeard:

My 2cents.

Passive investors rely on the efficient market hypothesis to make above average returns. Active investors make markets more efficient because they look for opportunities, i.e. inefficiencies within the market. As a result, passive investors actually rely on active investors. While active investors don't directly rely on passive investors, one could argue that the more passive investors, the more inefficiencies within the market exist, allowing active investors to strike and make money. This bilateral relationship will never cease to exist.

However, there is currently an unprecedented number of investors on both sides, and the active management space is evidently more affected. I believe this is because there is a critical mass of active investors needed to reach the efficient market hypothesis, but anything beyond this mass is a waste.

I think you're slightly mis-stating the argument that passive is making. I've always viewed it under a strong-form EMH lens as "The average investor earns the average return before fees, everything else is luck." The logical follow-on to that is that trying to be average at the lowest cost possible gives you the greatest chance of the highest average return.

Is strong-form EMH proven to be true? Definitely not. Is it close-ish to true? <eh, maybe?> Does it require people like active managers seeking to actively price things correctly? Definitely. One thing that I do see is that fee compression is real. If you can only deliver 50bps of active outperformance through your decision making, you can't charge 1.3% anymore. Not only is this being driven by passive, this is being driven by low knowledge investors exiting individual security investing. For every winner there has to be a loser in finance, and if uncle Ernie isn't investing based on a 'hot tip from this guy his barber knows,' then there won't be as much low hanging fruit for active managers to beat.

Broadly, I do agree with your statement. Do you have any suggestions on how to make Amtrak suck less? I would greatly benefit from that.

    • 2
Oct 22, 2017

I think HF will progressively be more liquid and cheaper...so that in europe alternative Ucits will recover part of the land lost to ETF

And also consider that ETF are not perfect, they are already creating some bias in the market..if they continue to grow there will be space for active investments

Oct 22, 2017

In my view, the transition isn't so much from active management -> passive management, but rather high cost -> lower cost as technology and scale have introduced cost efficiency. There will always be room for active management as it is a necessary condition in order for markets to be long-run efficient, but active management is also broadening. Where active management used to all be conducted by fundamental analysts, technology has now split the active management pie between fundamental strategies and quantitative strategies - both of which are forms of active management.

The way I picture it, quantitative strategies are about gaining a small informational advantage on average across a large breadth of securities (small edge on a lot of small bets) and in order for fundamental active management to have a place in the market it will need to be about having a large informational advantage on average across a smaller breadth (humans reading 10-k's and thinking about the business cannot realistically compete with computers on breadth). The question then becomes whether fundamental active management can be deployed in a manner that justifies the cost - i.e., can that large informational advantage be obtained cheap enough to compete with quantitative strategies. In my opinion, the answer is that the market will shake out and there will be an "equilibrium" that includes a balance of passive and active management as well as fundamental and quantitative, but what I can't tell you is what the market clearing "price" will be on fundamental active management except that it's looking like it will be a lot lower than in the past due to the competing factors I've mentioned.

    • 2
Oct 21, 2017

Might be biased but heard from a BB head of AM that while passive is gaining more steam we could see the process for active management come back in a few years?

    • 1
Oct 22, 2017

If you click on my responses to other threads you will see a response to a similar question. To expand on those, I will also say that it seems to me that active managers became fat and happy with their positions (i.e. they deserve the passive wave).

If you want to manage a mutual fund targeting retail clients for an insurer/fund company then that is declining/dead (IMO) unless you have performance or exceptional marketing. I say dead because the Vanguards and roboadvisors of the world have conquered the marketing landscape for the retail client (conquered may be a strong word but they are clearly winning).

The skilled active manager can and will outperform, and in this environment will do better and better (because his active flows have more and more influence over the passive flows) if he/she is of the "most skilled."

Embrace the markets. They are not going anywhere. If you are looking for the best risk-reward, this probably isn't the area though.

Oct 22, 2017

Awesome, thanks a lot for your response! I'm a 2nd year in school just trying to figure out what route I really want to take. I think AM is definitely for me but because of the somewhat bearish outlook I'm going to keep my mind open to other options.

Oct 22, 2017

Come to the debt side: http://www.wsj.com/articles/one-place-where-passiv...
In my opinion though, we'll always be needed to a fairly large extent. I think the "major shakeup" outlook is a bit overblown. People will always need investments outside of an index to hedge/diversify and there will always be speculators trying to outperform. Will it dampen the growth for general AM? Maybe a bit. But the same major players will always need us and there will always be the specialized active strategies.

Oct 22, 2017

They say they're better on a risk adjusted basis which can often be the case.

They also say they're not like the majority of active managers who suck

They could even say that over time their stock picking process will outperform, but yearly their results will vary.

Oct 22, 2017

Everybody would just say that they are superior to the statistical average. It's the investor's job to determine how much of a manager's claim is just self-serving bias/Dunning-Kruger effect and how much is real.

Oct 22, 2017

i can just speak for my own return which is way ahead of any bond or equity index over the life of my career....really anyone who did well during the crisis should have a oretty good cushion in terms of performance versus the indices. but if my results werent good i could resort to the usual tactics which include claiming that the PnL wasn't my responsibility, closing one fund and opening a new one, flat out lying, or some other shenanigans.

Oct 22, 2017
Bondarb:

i can just speak for my own return which is way ahead of any bond or equity index over the life of my career....really anyone who did well during the crisis should have a oretty good cushion in terms of performance versus the indices. but if my results werent good i could resort to the usual tactics which include claiming that the PnL wasn't my responsibility, closing one fund and opening a new one, flat out lying, or some other shenanigans.

Ha this is basically what FX Concepts is trying to do here. Taylor and team are blaming their woes on central bankers and are in the process of shutting down the shop and most likely attempting to start another one.
At least Taylor is sharing the pain by selling off his Manhattan apartment, financed with a loan from FX Concepts.

Oct 22, 2017

Depends on the strategy. S&P isn't necessarily the correct benchmark to be using.

Oct 22, 2017

If your numbers are good, you just show those.

If they're not:
-- Cherry pick the time period where you do look good
-- pick some other benchmark or statistic that shows you looking good
-- Wow someone with stories/numbers about how your investments are poised to do well
-- Focus on something other than performance that your firm offers (like brokers or private banks often do)

Oct 22, 2017

http://papers.ssrn.com/sol3/papers.cfm?abstract_id...

In short, non-closet-indexers actually add value, for the most part.

Oct 22, 2017

Here's what I say...

One of the most galling issues with academic studies of active management is that they seek to compare the "average" active manager with a benchmark. However, the benchmark is itself an average of managers. There's a raft of data showing that the average pension fund doesn't outperform pension benchmarks, that the average equity mutual fund doesn't outperform the S&P, or that the average hedge fund doesn't outperform a hedge fund index (this last one is especially absurd because the hedge fund index is explicitly composed of hedge fund returns, plus it has survivorship bias). But of course they don't!

Think about it - the performance of the market is already the aggregate performance of all market participants. If you take a large enough group of managers over any one period of time and average them together, you're likely to get something very close to the index. The only reason there's any potential divergence at all is the existence of passive strategies and anyone transacting indiscriminately (say, retail investors or stock comp and buyback plans). Non-fundamental buyers and sellers are what create the opportunity for fundamental managers.

What's remarkable is that many of these studies have actually proven the point - when they look at all active managers taken together, the intercept is pretty close to zero, NET of fees. You'll often see the claim then that active managers don't add any value to clients collectively. But what I find more interesting is that the result implies managers actually do add value on a gross basis, even after research and transaction costs, at least compared to passive strategies. Maybe fees (again, on average) are a bit high, but it's what the market will bear. And that's also after including all the bad managers, gamblers, traders, and others you might not expect to add value over the long run. I think the entire argument for the existence of the fund of funds industry (where incidentally fees are also too high) is that by just weeding out the obviously bad guys, you'll be left with a group that might actually beat a benchmark.

As hard as it is to pick out good managers from the crowd, especially since even good capital allocators can suffer periods of underperformance, these studies try to show that passive strategies are just as good as an average manager. That's something, I guess. But looking at the collective performance of the industry does nothing to disprove the value of the individual.

Oct 22, 2017

2 things here:
- Funds can say that the last x number of years has featured the abnormal environment of all the Quant Easing and which resulted in all stocks rising and correlations between the stocks rising therefore rendering a stock pickers skills less valuable. When interest rates return to normal, that correlation will drop and you'll want someone who can pick stocks
- Larry Fink of BlackRock recently did an interview where he said that something that doesn't show up in the numbers is that many active managers actually use ETF products to gain exposure to sectors/themes etc. So when you see all those flow numbers into ETFs - that isn't just all passive investors

Oct 22, 2017
Comment
Oct 22, 2017