Passive investing’s popularity puts pressure on active managers

BALTIMORE — Passive investment strategies, which aim to match market benchmarks like the Standard & Poor’s 500 rather than beating them, have been gaining popularity for years.

Easier to manage, such funds typically charge lower fees, which explains part of their appeal to investors.

But as the trend accelerates, it brings new attention to how money managers with active strategies at their core, including Baltimore-based T. Rowe Price Group and Legg Mason, are responding to an investment strategy that appears to be here to stay.

“E v e r y m o n e y m a n - agement firm is having to respond to this,” said David Berman, co -founder and CEO of Berman McAleer, based outside Baltimore.

It’s real. It’s not a fad. It’s not going away.”

Both T. Rowe Price and Legg Mason are feeling the pinch.

For the third quarter, T. Rowe reported growth in earnings and assets under management, and said 84 percent of its mutual funds beat Lipper averages for similar funds on a total return b a s i s f o r t h e t h r e e - ye a r period ending in September. Yet investors withdrew a net of $200 million, largely from the fifirm’s actively managed stock funds.

Legg Mason reported outflflows of $1.5 billion from its equity funds, for a net outflflow of $300 million for its July-to-September quarter, while also growing earnings and total assets under management.

Ac t ive managers, who handpick stocks they think will rise, have struggled to beat the market in recent years.

Add in growing attention to the typically higher fees such managers charge, and more investors are moving their money away from active funds to passive alternatives, with their lower fees and lower risk.

With about three-quarters of invested money in the United States held in actively managed funds, the trend is more of a thorn in the side of large active managers than a destructive blow, but nonetheless they can’t ignore it, experts said.

“Active management will still exist, but you’ll have to do it better and you’ll have to do it less expensively, and that’s the pressure T. Rowe and Legg Mason and others are feeling,” Berman added.

T. Rowe, Legg Mason and dozens of other money man- agement fifirms rely on portfolio managers to pick and choose the best stocks and funds to invest clients’ money in, with the goal of performing better than benchmark indexes, such as the S&P 500, which includes the stocks of 500 large companies.

Conversely, passive funds aim to mimic the indexes, including in their portfolios the indexed companies’ stocks. The goal of these funds is to match the market, not beat it.

F i n a n c e exp e r t s a t t r i - bute the rising popularity of passive funds to a greater awareness among investors of the fees they are paying for actively managed funds — many of which aren’t beating the indexes.

“I think investors are starting to realize they’re paying all these fees for ac tively managed funds and there’s no guarantee they’re going to outperform,” said Mark Johnson, an assistant professor of fifinance at Loyola University Maryland. “They’re asking themselves, ‘Why am I paying for something I may or may not get?’”

The popularit y of passive investing will put pressure on active managers to beat the benchmarks, and on investment fifirms to be more competitive with their fees, he said.

“They’ve always had pressure to do well and perform,” Johnson said. “This is going to put more pressure on them.”

The way active managers have responded to the trend varies widely.

About 20 years ago, Fidelity, one of the largest mutual fund companies in the world, adopted a new strategy to give passive investing a much larger role in its business, s a i d Br i a n Hogan, pre s i- dent of Fidelity’s equity and high-income division. Today, the Boston-based fifirm has about $230 billion in passive assets, or just under 11 percent of its total assets under management.

Passive funds are on the menu for clients of T. Rowe and Legg Mason but remain a smaller part of business. A b o u t 5 p e r c e n t o f t h e roughly $813 billion in assets under management at T. Rowe is invested in passive funds, for example. Legg Mason does not break out its passive assets from its roughly $716 billion in assets under management because it is a small amount.

Rather than make passive investing a separate silo within their business, T. Rowe and Legg Mason recommend clients adopt diverse portfolios with a mix of active and passive investments.